• Labor market showing mixed signals

  • Continuing jobless claims declining since Mar’23
  • Non farm payrolls declined MoM
  • However, unemployment rate came in lower at 3.6% vs 3.7% (previous month)

• Services PMI in expansionary phase

  • Stays above 50 (expansion) mark for the 5th consecutive month, although declined sequentially
  • As also indicated in sticky core inflation

• CPI inched up in Jun’23 to 4.81%

  • Higher vs the market expectations as well
  • Led by cereals, pulses and spices
  • Core CPI eased by 9bps to 5.12
  • Weather related disruptions pose a risk
  • Impact of tomato prices to show up in next print

• RBI’s FY24 CPI Forecast revised down by 10bps to 5.1%

• CPI to move above 6% based on seasonality

• Do yields track inflation projection? No.

  • Orange area (chart) is 10Y yields, Black line is CPI

• Can forecasters predict Indian CPI? No.

  • Green line is forecasters prediction of CPI 1-Year later
  • Blue line is where inflation actually came
  • Guess the error of margin!

• CPI forecast corelated (not causality) to yields

  • Low predictive power, high current corelation

• El Nino a real possibility now

  • Sustained negative values of the SOI lower than − 7 often indicate El Nino episodes.
  • India monsoon rain in surplus on overall basis
    • ✓ But with heavy spatial and temporal skews

• El Nino impact on cereal prices was inconclusive as per past data (refer to table below)

  • However, deficient rainfall could impact rice sowing
  • Wheat and rice stocks on the lower side

• Domestic growth data still robust

  • PMI continues to be in expansionary mode
  • Consistently high services PMI (Jun at 58.5)
    • ✓ Even though it declined sequentially
  • GST collections at ₹ 1.61 tn; YoY growth at 12%

• Strong credit growth

  • Led by retail, MSME and services
  • Credit to large industry also picking up (specially in infra related sectors)

• How closely do yields track growth?

  • Yields have usually tracked GDP growth, with correlation being stronger when growth slows, barring
    • ✓ 2013, rupee depreciation and debt outflows
    • ✓ 2017, during demonetization

• FY24, growth may not be big driver for yields

  • FY23 GDP came in at 16.1%, in line with RBI projections

The checklist for pause:

• When the US Fed starts pausing

  • Reduces risk of capital outflows

• When inflation is within comfort

  • Reduces risk of inflationary policy
  • Barring 2014, when RBI did not have 6% CPI target
    
    • ✓ But CPI was falling in 2014

• When BoP (and currency) is stable

  • Reduces inflationary / external risks

How is the checklist now?

• ↔ US FED has indicated two more hikes

  • Even though FED has paused the rates for now.
  • US yields much lower, expecting rate cuts in CY23

• ✓ Inflation moderated to comfort zone

  • CPI <5%, but will increase further

• BoP (rupee) is stable

  • Bop in surplus in Q3 and Q4FY23

• RBI FX reserves have increased significantly

  • Forex reserves increased significantly to USD595bn

• RBI FX Reserve / IMF FX adequacy ratio declined sharply

  • Buffer of ~USD 93 bn to reach 2013 and 2018 levels (~150% ratio)

• RBI only hiked rates twice in past 10 years, barring now

  • Increased rates to control rupee, not inflation

• RBI has tolerance for inflation, not rupee fall

  • In 2018, inflation was within RBI’s target levels
  • In 2013, inflation was high for long yet RBI cut

• When RBI FX reserve fall

  • RBI avoids using reserves and does rate hikes to control rupee.

• Fed paused in the June’23 policy

  • RBI has echoed FOMC decisions, albeit more moderately
  • RBI started hiking after Fed
  • RBI rate hikes 25bp lower than Fed – in every policy

• FOMC DOT PLOTS expects two more rate hikes.

  • If FED hikes twice, probability of MPC hikes
  • We do not expect RBI hikes to occur, but “probability” will be priced by markets

• FOMC expects rate cuts in 2024,

  • A 100 bp rate cut expected in 2024
  • But there is a wide dispersion – signifying data dependence

• State cash balances back above ₹ 2 trillion

• Center has front-loaded devolution of tax

• Last time we said: low cash balance resulting in higher issuance

• Now expected to be in line with the calendar /marginally lower at best

• SDL borrowing has now normalized

  • Apr’23 borrowing 60% lower than calendar
  • May’23 higher than calendar (Rs 3k cr)
  • June’23 borrowing largely in line with calendar

• SDL issuance impact expected to be limited

• Banks SLR holdings has risen sharply

  • Part of SLR holding (~1%) is hedges of FRA & TRS, and not naked holdings
  • Yet, SLR holding remains high

• SLR ratio may reduce, still absolute demand will absorb supply for FY24

  • Natural NDTL growth will still lead to demand

• But banks have bought nearly ₹ 2 tn in Q1

  • Rest of the year demand will be muted

• Yields track RBI OMO purchases

  • Yields have strong correlation with RBI OMO
  • Demand/Supply mismatch is filled in by RBI

• RBI OMO pushed to latter half of FY24

• RBI announced withdrawal of ₹ 2000 notes (Demonetization 2.0)

  • 76% of ₹ 2000 notes (2.7 tn) in circulation already returned as of Jun’30
  • Of this, ₹ 2.37 tn in the form of deposits

• Core liquidity comfortable at more than ₹ 2.5 lac crores

• RBI announced dividend of ₹ 87K cr

  • Surpassing budget estimates of ₹ 48K cr

• Liquidity to remain in surplus for few months

  • Due to seasonality of liquidity
  • Seasonal infusion of ₹ 45-60K cr as we enter a period of reversal in CIC until Q3FY24

• OMO/CRR possibility pushed to Q4/Q3

  • Liquidity infusion will not be needed

• FOMC rate at 5.25% - more hikes at play?

  • Labor data has softened, but no conclusive evidence yet
  • Tails risks of services inflation remaining sticky

• Are spreads of US Treasury and Indian Govt. Bonds low?

  • No, Bond yields difference mimics the inflation and policy rate differential.
    
    • ✓ 10Y yields seem to have priced in the inflation spread

• Even if US yields don’t fall, Indian yields may.

• Are Indian yields tracking US Rates/currency /crude? NO

  • Currency is stable
  • Trade deficit reduced significantly
  • India yields more driven by the local factors

• Is Election Year bugle sounded by MSP hikes?

• MSP hikes are substantial

  • Could lead to further inflationary pressures.

• But can be offset by Pulses and Paddy buffer

  • Govt. has substantially large buffer

• Although MSP hike in this election year has been lower than the previous election years

• Higher supply of corporate bonds so far

  • 2mFY24 issuance at 2.5x of 2mFY23 led by AAA & AA rated segment
  • AAA supply increased from ₹ 59k crores in May to ₹ 77k crores in June
  • PSU supply has picked up along with NBFCs

• Issuances expected to remain steady going ahead

• The corporate bond spread remains elevated

  • 3Y NBFCs providing steady accrual
  • AAA PSU Spreads remain to be in the narrow band of 50-55bps
  • Demand-supply well-matched & expected to remain the same