Mahendra Kumar Jajoo, CIO, Mirae Asset Investment Managers, says . “I expect the Fed to cut rates in July-August. The rate cut cycle will be shallow. The Fed will cut to reverse the ultra-aggressive rate hikes of the last 100 basis points and then the Fed will watch how things evolve.”
Jajoo says as far as India is concerned, “our inflation has now come below 5%. RBI is projecting an inflation of 4.5% in two quarters’ time. So, with the repo rate at 6.5%, with the fiscal deficit being in a very strong situation, with the projections for the next year’s fiscal deficit at 4.5%, with the monsoon forecast being normal and with the global rates expected to come down, there is space for the Reserve Bank to cut rates.”
A lot has changed in the last few days, especially talking about the latest development on the geopolitical front. We have seen a great runup in gold and crude prices. We have spoken so many times about rate cuts and continue to do so as nothing has materialised. How would you analyse the situation of uncertainty so far for equity as well as debt markets?Mahendra Kumar Jajoo: A lot of things have happened and the developments have been very fast-paced in the last 15 days. But like in the last year also, we were saying that markets were at that point too optimistic and now things are evolving in a way that in my personal opinion the space for the rate cuts has opened up for the Fed as well as for the Reserve Bank. However, there is still going to be some watch before they can cut the rates.
As far as the Fed is concerned, the market is worried about the inflation going higher than what the market was expecting and therefore there is some concern in the market that the Fed rate cuts may be delayed. I would like to believe that if the inflation remains at around the current levels, then it will be possible for the Fed to cut rates sometimes in July and August. Somewhere in the next quarter, we can expect a rate cut. The reason is that while the inflation is not coming down closer to the Fed’s target, still the real rates in the US are very high.
Inflation was at 9% when the Fed rate was at 5.5%. Inflation is now at about 3.5-4%. So while the Fed cannot go back to zero percent rates, it can easily come close to 4.5-4.75%. I believe the Fed can cut rates by 50 to 75 basis points in the next six months. That does not mean that the markets will have to rally because to a large extent the income is already inverted, so a bit of discounting of the possible Fed rate cuts has already happened.
So far as India is concerned, our inflation has now come below 5%. RBI is projecting an inflation of 4.5% in two quarters’ time. So, again, with the repo rate at 6.5%, with the fiscal deficit being in a very strong situation, with the projections for the next year’s fiscal deficit at 4.5%, with monsoon forecast being normal and with the global rates expected to come down, there is space for the Reserve Bank to cut rates.
But we are now dealing with a new development on the geopolitical front. Iran and Israel conflict news is coming, that will have impact on the energy prices, that will have impact again on the global supply chain. Therefore, the central banks will be a little watchful and RBI may cut the rate one or two times after the Fed starts the rate cut process.
Let us talk about the US specifically. Do you see an inflation boom coming over there because the kind of data that is coming up which is quite robust, do you really think the stand will not change and you are still looking at rate cuts or do you think this situation is further to be analysed depending on the data if it continues to be robust or according to you, what kind of data is pointing towards a rate cut in the time horizon that you mentioned?
Mahendra Kumar Jajoo: When the central banks are at a pause, the market has far more elbow room to be volatile. So, every data point that comes in leads to fresh expectations and resetting of the earlier expectations and therefore the markets can turn volatile. Just three months back, if you look at this environment, markets were betting on a 150 basis points rate cut. Has the environment changed so much that now people are expecting no rate cut? I think that kind of volatility in the market is normal especially when the guidance from the central banks is somewhat fuzzy and that is what has happened.
The market has swung from expectations of a deep rate cut to no rate cut to delayed rate cuts. This is not the first time this is happening. We are in the first fortnight of April. In March 2023, when the California Bank had collapsed, at that point market had factored in a near certain possibility of a rate cut by Fed in April, May of 2023 and from that situation by the time October 2023 came, market was braced for higher for longer rates and then by November 2023, Fed was already talking of possible rate cuts.
I think the environment is so volatile and fragile that month to month, data to data, the market expectation changes very frequently. But the core fundamentals have not changed so much. So, the fact that inflation has fallen from a record high of the last 40 years to a more manageable level, there is no immediate threat of runaway inflation. There is a possibility that the inflation remains sticky at around current levels.
There is a possibility that inflation goes up somewhat because of the base effect, because of the renewed momentum in the energy prices, because of the renewed momentum in the other commodity prices, because of the possible disruption in the traffic movement in international trades because of the geopolitical conflicts. But it does not change the base situation that in the last leg of the rate hike cycle, Fed was ultra-aggressive. They hiked the rates by 100 basis points when the inflation was very high. From those levels, the inflation has come down significantly.
So, even though the market is very volatile and the mood swing is very-very dramatic, I think the core approach to a gradual easing of the rates from their recent high is still valid. I expect the Fed to cut rates in July-August. The rate cut cycle will be shallow. The Fed will cut to reverse the ultra-aggressive rate hikes of the last 100 basis points and then the Fed will watch how things evolve.
As far as India is concerned, as I already explained, macro environment is absolutely fantastic and then if you have a normal monsoon, of which we will have a fair idea by June-July, RBI will be in a position to indicate if the rate cuts can start at that point. But again, in India also, the rate cut will be very shallow, maybe one or two 25 basis points rate cut.
Talking about the triggers that are there for us, IMD predicted a normal monsoon and El Nino weakening. But what is the status as far as La Nina is concerned because it has a completely opposite nature of an El Nino. What if reality turns out to be different from predictions? So far, we have come under the comfort band of RBI as well. But then if fuel prices go up, we will again see food and fuel inflation becoming a problem for us.
Mahendra Kumar Jajoo: Let us first put the record straight. If the monsoon is delayed or if the monsoon is deficit, if the oil prices go up to $100, obviously the assessment will have to be revalidated and if the new assessment says that no rate cut, then no rate cut will happen. So, precisely because the environment is so fragile and things can change overnight because of the geopolitical events or because of the climatic events, the central banks are very watchful, which is why if you look at the last guidance of the Reserve Bank, it says look there is not even a discussion of a rate cut on the table. That is showing the cautiousness and recognition of these uncertainties in the market.
Now, what happens if these uncertainties do not come into play? My personal view is that the monsoon will be all right. There is another very important development that we have to take note of. In the last two years, the inflation has been controlled to a very reasonable level in India because of the active supply management measures taken by the government of India. We have seen the ban on wheat exports. We have seen a ban on sugar exports. We have seen multiple measures taken by the government to ensure adequate supply of pulses or of other agricultural commodities into the market.
Therefore, apart from the impact that the monetary policy has had on the inflation, there has been a very significant contribution by the pre-emptive and effective measures taken by the Government of India on the supply side and we have seen the Reserve Bank go on a pause in February 2023 itself while the Fed was still hiking rate, because the Reserve Bank also spoke about the supply side measures being taken by the Government of India in its policy documents, so it is a combination of the fiscal, administrative and monetary measures that has ensured a steady state inflation in India.
There is no reason to believe that this will just disappear overnight and therefore, I think it is a fair thing to assume that inflation will remain well behaved in our country, unless obviously, there is a major disruption because of the geopolitical environment, in which case obviously the assessment will have to be rebased.
So, it is time to go in for short-term strategies in debt, in case you want to park in there or do you think it is the time to consider long term, if at all, debt mutual funds or any other fixed income as an investment instrument that you want to consider?
Mahendra Kumar Jajoo: The way the equations are right now, we are looking at no possibility of a rate hike by all practical means. So, the debate is between no cut and a possible rate cut. To some extent, the markets have already discounted rate cuts sometimes in August, September, or people who are very conservative in November, December, those expectations can change.
But the likely change in the expectation is from a rate cut forecast to a no rate cut scenario. Therefore, to the extent that interest rates are already at close to their current cycle high, to the extent that the liquidity is still just about balancing, it just last 15 days that the liquidity in the system has improved, but before that because of the tight liquidity, the interest rates have been higher even at the shorter end and the curve was very flat.
So, to that extent, it still makes sense to remain invested at the far end of the curve. But now, there are, for the last 15 days developments that are putting a doubt in mind on the possibility of a rate cut, putting a doubt in mind on the timing of the rate cut, therefore obviously immediately there is a bit of adverse reaction in the market.
For those who believe in the macro fundamentals and in the core inflation remaining well behaved both domestically and globally, it is an opportunity to add to the portfolio. For people who do not have that kind of confidence in the inflation projections, for them maybe there is some reason to become a little sceptical. I am in the camp that looks at the current disruption in the market as an opportunity to add further to the portfolio because the underlying fundamentals are strong. We have also seen that increasingly, there is divergence in monetary policy globally.
So, the Fed is still very circumspect, while ECB has given a clear indication of a rate cut in the June policy. India is somewhere in the middle. So, even if the global interest rates go up, because of the domestic factors which are prevalent in the US, it does not mean that for Indians also,it has to go up. Ahis point one should be more constructive and optimistic than being sceptical and miss out on the opportunity.
