When you can expect interest rates to rise – The New Indian Express

Express News Service

To say that interest rates have to rise is stating the obvious. Supply side pressures are real, Indias growth is coming back strongly, and we cannot be immune to global developments. However, while this expectation makes for a good summary headline, it is equally important to scratch beneath the surface and enter the realm of nuance when one is talking about portfolio constructions and optimal strategies.

First, and what is noteworthy about these global developments as highlighted in yield curve movements above, is that the market is not resetting higher the peak policy rate expectations. If anything, these are being brought down, likely for the reasons mentioned above. In that sense, this is a very different global cycle than 2003 - 08 and will likely be much shallower, marked with significant global growth volatility from quarter to quarter. Thus, our lower-than-last-cycle peak rate expectation probably holds even for the arguably most near-term over-stimulated large global economy.

Second, Indias realities are somewhat different than many other economies around the world. We rush to clarify that this observation is not meant to justify insulation to global developments (after all emerging markets will get constrained by tightening in developed economies) but to merely draw some distinctions around the likely path of policy ahead. In our view, the defining distinction for the intensity of the inflationary shock and its probable persistence is the quantum of the fiscal response administered as Covid response.

As is well known, the US saw an unprecedented fiscal stimulus over two calendar years, arguably much in excess of the size of the problem. Some other economies were relatively more modest in their response, but standalone still quite significant. Even some emerging markets went aggressive with their fiscal expansion.

In contrast Indias response was very nuanced last year focusing on direct spending for welfare of the most susceptible citizens while using credit and liquidity measures largely for the industry in general. With the crisis stabilising, the fiscal stance has turned even more nuanced this year with the year to date deficit the narrowest in many years on a variety of parameters. Given this, while supply side pressures are very much showing in Indias inflation as well, CPI isnt on a runaway trajectory and second round permanent effects in terms of expectation setting are likely to be much more contained. This, and RBIs aggressive accumulation of forex over the past year and a half, both provide some cushion to the central bank in charting a more localised path to normalisation of policy.

It is also for this reason that we will not attempt to force-fit the bearish flattening of the curve in some of the advanced markets to India. The base case remains that in Indias context, the absorption of gross duration supply is likely a greater dynamic to fear than the monetary policy normalisation ahead. The recent few weeks have been extremely tough for global rates, especially in some key developed markets. India has had its rub-off as well, as should be expected since its hard to think about our markets in isolation.

That said, the differentiator in our view is our more nuanced fiscal response and the laser-focus from RBI in accumulating a forex defense. While even this doesnt insulate us, it does provide certain more degrees of freedom to monetary policy. After the recent sharp rise in yields, the interest rate swap market is no longer a cheap or effective way to hedge against the normalisation already underway.

Indias fiscal responseIndias response was very nuanced last year focusing on direct spending for welfare of the most susceptible citizens, which turned even more nuanced this year. Given this, while supply side pressures are very much showing in Indias inflation as well, CPI isnt on a runaway trajectory and second round permanent effects in terms of expectation setting are likely to be much more contained

(The author is Head of fixed income, IDFC Mutual Fund)

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When you can expect interest rates to rise - The New Indian Express