Adding to bond market woes, equity markets sold off globally this week, which paradoxically was the result of good news, not bad. Friday’s US non-farm payrolls (NFP) data showed annualised wage growth in Jan ‘18 at 2.9%, highest since 2009 (the broader underemployment index, U6, was also tight). This was a long overdue correction, and not particularly worrying. Will (and should) this market volatility influence the Monetary Policy Committee’s (MPC’s) decision? It will, but probably not overly, being in the nature of risk correction. What will be closely watched are signals on US interest rates (the next Fed FOMC meet is on March 21, the first with Jerome Powell as Chair). US futures markets are now pricing in a >60% probability of three or more US rate hikes, with about an 83% probability of the first hike in March. Even Eurozone rates are now pricing in a rate hike within the next year.
Commodity prices remain high, including metal prices, which are more reflective of global growth expectations, particularly China. India’s inflation trajectory will keep rising over the next 5-6 months, and the “super core (ex-food, fuel, diesel, petrol and housing)” inflation has also been rising. Output price inflation has also lagged input inflation but this is likely to start catching up as excess capacity narrows. The Budget’s proposal of minimum support prices (MSP) at 1.5x cost for the next kharif crop’s might not be unduly inflationary, but there is a clear impact of food prices on inflation, which had been tempered in the past few years because of the drop in commodities prices. Household inflation expectations (to which RBI pays significant attention) had also picked up in November and are expected to rise further as captured by the new release today, due to the saliency effect of the recent rise in fuel costs and vegetables prices in December.
Fiscal uncertainty has added to concerns on rising inflation. The Union government slipped on its fiscal path after many years—of course, understandably, post the disruptive fundamental structural changes—and the FY19 fiscal targets also depend on a sharp rise in GST collections. As has been emphasised, the fiscal conditions of states has also been a rising concern, probably more than that of the Centre. Most MPC members had already expressed concern with rising prices, and the text in the December 2017 policy statement, of “risks being evenly balanced” for the 4.3-4.7% inflation forecast for Q4 FY18, will likely be dropped or replaced by “upside risks”, although the range may be maintained.
Bond markets have been bearish due to a multiplicity of factors, especially the fiscal uncertainty, and yields have risen sharply over the past months. The multiplicity of rates requires some attention, but each one of them tells a story on underlying economic, liquidity and credit conditions. The steep rise of shorter tenor rates (commercial paper, bank certificate of deposits) can be partially attributed to tightening liquidity, as reflected in net borrowing from RBI liquidity facilities. One reason for this liquidity shrinkage is the rather striking quantum of cash withdrawn from banks in FY18. The big concern is that this rise in market interest rates will gradually percolate across most borrowing rates, which is an environment of fragile recovery, and become another barrier to sustained recovery, particularly in the atmosphere of weak investment.
Senior vice-president, Business and Economic Research, Axis Bank
With contributions from Tanay Dalal
Views are personal