Quantum Mutual Fund -Year End Outloo

 

Good Time to Be Bond Investor

Year 2023 can be characterised as a year of great volatility. Throughout the year, global bond market was toggling between two opposing narratives - “persistent inflation” and “recession” – particularly in the United States. Central bankers’ data dependency and volatile economic data too kept bond markets at the edge.

Going into 2024, outlook for the bond market and the fixed income as an asset class has improved greatly. There are many reasons to be positive on the bond market. We shall discuss some of them in subsequent sections.   

For starters, the rate hiking cycle has peaked and the rate cutting cycle is about to begin. Inflation is cooling off along with slowing global growth. High interest rates, declining growth and heightened geo-political tensions have increased the risk of financial or economic shocks.

Domestically, demand supply dynamics in the bond market is looking more favourable with robust tax collections, government’s fiscal consolidation plan and India’s inclusion in the global bond index.        

Monetary Policy – Heading for Reversal

Heading into 2024, central banks’ tone has begun to shift. In contrast to its higher for longer message just two months back, the US Fed has now readied itself to talk about rate cuts.

More importantly, it doesn’t see recession as a pre-condition for rate cuts; “just a sign that the economy is normalizing and doesn’t need the tight policy” will be enough for the FED to move.

The Dot Plot which indicates FOMC members’ projection for the Fed Funds rate, is now showing about 75 basis points (100 basis points = 1%) of rate cuts in 2024.

            Chart – I: US Rate setting panel (FOMC) is indicating 75bps rate cut in 2024

             Source – Bloomberg, Data as of December 13, 2023

Yellow dots represent each FOMC members’ projection of future Fed Funds Rate; the green line shows the median estimate for the same.

Other major central banks are not as explicit in their commentaries. Instead, some pushed back on the rate cut calls; like the ECB President Christine Lagarde countered - “We should absolutely not lower our guard”. And the BOE governor, Andrew Bailey, observed that “there is still some way to go” in the fight against inflation.

Nevertheless, they also highlighted that the full effect of higher interest rates is yet to come through. Therefore, they must remain vigilant to financial stability risks that might arise.

Overall, the policy undertone has turned less hawkish or incrementally dovish across the board indicating the worst of rate hiking cycle is now behind us. 

Back home, the RBI governor Shaktikanta Das, for the first time in the last two years, cautioned to the risk of overtightening the monetary policy.

He also noted – “We have now reached a stage when every action has to be thought through even more carefully to ensure overall macroeconomic and financial stability; more so, because the conditions ahead could be fickle.”  This is a big shift from the RBI’s policy making with Arjuna’s eye on inflation.

At this stage, the RBI seems more worried about potential shocks to the financial system and the growth outlook from fragile external environment.  This will probably tilt the RBI’s reaction function more towards global macro environment and monetary policy cycle.

So, even if domestic inflation remains above 4%, the RBI might cut interest rates in response to worsening of global economic or financial conditions. Nonetheless, inflation outlook too looks supportive for the monetary policy.

The Core Disinflation

India’s Inflation trajectory has improved tremendously over the last few months though it didn’t get much attention due to volatile and generally high food prices which kept the headline CPI inflation elevated for most part in 2023.

As per the latest data, the headline CPI inflation stands at 5.6% in November 2023. As per the RBI’s projections, headline CPI inflation is expected to average at 5.4% in the fiscal year 2023-24.

However, if we strip out the impact of food prices, inflation for other goods and services (CPI ex-Food) now stands at 3.6%. Another popular measure - the Core CPI inflation, which excludes the food and energy prices has come closer to the RBI’s 4% target and is expected to slide down further in 2024.

Chart – II: Falling Core Inflation (ex-Food and Fuel) to ease pressure from the RBI

Source – MOSPI, Quantum Research, Data upto November 2023

Although the RBI’s target is based on headline CPI, it would draw comfort from falling core inflation which tends to be more sticky.

As far as food inflation is concerned, monetary policy has a limited role to play. In this regard, the RBI worries more about the second-round impact of food inflation – high food prices feeding into inflation expectation and pushing up prices of other goods and services.   

A crucial point to note here is that despite elevated food inflation, inflation expectations of Indian households have been very well anchored. As per the RBI’s inflation expectation survey, households’ perception of current inflation and expectations of future inflation have been coming down consistently in 2023 except for a marginal uptick in the one year ahead inflation expectation in November.

Chart – III: Despite elevated food inflation, household inflation expectation is very well anchored

Source – RBI monetary policy document, December 2023

To put this in context, there is no sign of second round inflationary impact of high food prices on inflation expectation or prices of core goods and services.

Thus, the RBI should not be overly worried about food inflation at this point. Having said that, this doesn’t open room for rate cut by itself. If at all, the RBI needs to cut rates in 2024, that would probably come in response to financial or economic shock from the external world.

From the market’s perspective, falling core inflation should lower the inflation risk premium on bonds by reducing the yield spread on government bonds over the policy repo rate. This in turn can bring down the bond yields even without a rate cut by the RBI. Any increase in the rate cut probabilities would further intensify the downward trend in bond yields.

Falling Bond Supply

After expanding the fiscal deficit to 9.2% of GDP during pandemic shock in FY2020-21, the government has been on a path of fiscal consolidation. The government has set a target to bring down the fiscal deficit to under 4.5% of GDP by FY2025-26 from the budgeted 5.9% fiscal deficit target for FY 2023-24.

Assuming the government will stick to this fiscal plan, the net issuance of government bonds would decrease by around Rs. 1.6 trillion over the next 2 years.

Chart – IV: Fiscal consolidation will lead to significant reduction in bond supply over coming year

Source – IndianBudget.gov.in, Quantum Research, Data for FY25 and FY26 is based on Quantum Research team’s estimates

While on the demand side, a healthy growth trend observed in the assets of long-term investors like insurance, pensions, provident funds etc. is expected to continue in line with the growth in the nominal GDP. The demand for bonds will also be boosted by India’s inclusion in the global bond index.

We might see a situation where demand outpaces supply in the government bond market over the next two years.

Index Inclusion and foreign demand

India will be included in the JP Morgan GBI EM Index starting June 2024 with an eventual 10% index weight to be reached by March 2025. This is expected to attract USD 25-40 billion of foreign inflows into Indian bonds over the next 12-15 months. {Why Soaring Oil Prices Couldn't Dampen Market Mood}

More importantly, index inclusion can open a source of consistent demand for Indian bonds from investors who track the index, particularly from the exchange-traded funds or ETFs. Even active investors will be more comfortable investing in India when it becomes part of the index.

Apart from the direct impact of additional demand, there could be spill-over benefits as well -   

§  The new demand source for government bonds might also help in deepening the corporate bond market in India.

§  Potential foreign inflows into Indian debt will expand the source of foreign capital which in turn will strengthen India’s balance of payment situation and deepen the market for the Indian Rupee.

§  Foreign holding of bonds would enforce much stricter discipline on the fiscal and monetary policy.

§  Increased participation by foreign investors, would enhance the credibility of the Indian bond market and will make it easier for the government and the corporate sector to raise debt capital from global investors.

So far in 2023, foreigner investors (FPI) have been consistent buyer in the bond market with net purchase of Rs. 568 billion (USD 6.83 billion) of government bonds (data upto December 19, 2023).  We expect the pace of foreign buying in Indian bonds to increase in 2024 with the global interest rate changing course.

Chart – V: Foreigners turned buyer in Indian bonds in 2023

Source – RBI, Quantum Research, Data up to September 2023

What should Investors do?

With high starting yield and expectation of fall in bond yields, we believe that long term government bonds offer investor a rewarding opportunity.

Dynamic Bond Funds are probably best placed to capture this opportunity with a flexibility to change if things don’t pan out as expected. However, investors need to have a longer holding period of atleast 2-3 years to ride through the intermittent volatility.  

Investors with shorter investment horizons and low-risk appetites should stick with liquid funds.

Portfolio Positioning

Scheme Name	Strategy
Quantum Liquid Fund	The scheme invests in debt securities of up to 91 days of maturity issued by the government and selected public sector companies.
Quantum Dynamic Bond Fund	The scheme to invest in debt securities issued by the government and selected public sector companies.   The scheme follows an active duration management strategy and increases/decreases the portfolio duration (sensitivity to interest rates changes) in accordance with the Interest Rate Outlook.   Given sharp drop in yields, we have trimmed down the high duration position in the scheme. However, the scheme still carries relatively high portfolio duration reflective of our positive medium-term outlook.

Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. 
Risk Factors: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Gold in 2023..

After increasing interest rates by a massive 425 basis points in CY2022, CY2023 saw only 100 basis points of hikes by the Federal Reserve. Thus, unlike the war-driven highs and hawkish Fed-driven lows of 2022, gold saw a steady rise in 2023, closing the year ~12% higher, as the US central bank’s peak aggressiveness was left behind. Not to say that there weren’t ups and downs though.

The precious metal saw a large up move at the start of the year in response to stress in the US banking system which triggered global risk aversion and expectations of a Fed pivot. But over the next few months, sticky US inflation and strong labour market data fuelled the Fed’s hawkish stance pushing gold prices lower. Fresh geo-political tensions in the Middle East, slowing inflation and concerns about a US economic slowdown in the last few months of the year brought with them renewed expectations of peak interest rates and softer monetary policy, pushing prices higher.

In its final meeting of the year, the Fed took a dovish stance maintaining the status quo on rates and signalling 75 basis points of rate cuts in 2024, up from its previous projection of 50 basis points. This triggered a substantial drop in US treasury yields and US dollar, propelling gold above the $2000 mark.

Central banks bought 800 tonnes of gold in the first three quarters of CY2023 providing a soft support to prices through the volatility of the year. While, global gold ETFs saw net outflows, domestic gold ETFs saw net inflows of Rs 2,831 crores year-to-date as of November 2023.

Price drivers in 2024..

1)      US economy and Fed policy

Fixed income market’s classic recession indicator, the 10 year- 2-year Treasury yield curve has been signalling a US recession since July 2022. Cumulative effects of the Fed’s rate hiking campaign of 2022 and 2023 are expected to show up soon. Tailwinds for US economy in the form of pandemic-era savings, loan moratoriums and low-rate debt are also behind us. With US economic data incrementally showing signs of cooling off, the deterioration in US growth is expected to become apparent in the first two quarters of 2024. This is anticipated to bring with it the next phase of the Fed’s policy, which has now been indicated by the central bank itself. Both the US slowdown and the resulting Fed easing are likely to make conditions conducive for gold prices in 2024 as attractiveness of competing asset classes diminishes.

However, the severity of the slowdown and the timing and extent of Fed policy easing remain uncertain.

If the growth slowdown is mild and is not accompanied by a moderation in inflation which is in line with Fed expectations, the central bank may delay easing. This could risk an overtightening of financial conditions which could deepen the US downturn or worse lead to financial accidents similar to the March 2023 US regional bank crisis. This scenario will destabilize risk assets and increase demand for portfolio diversifiers like gold. The Fed will eventually ease, but it will likely be ‘too little too late’.

Conversely, if the Fed has a lower tolerance for growth deceleration or the growth setback is severe, it could choose to loosen up financial conditions by cutting interest rates before inflation comes down to its defined targets. This, in addition to the fiscal spending in the run up to US elections, could fuel the inflation fire again, drive up inflation expectations, and hurt the Fed’s credibility. Gold will be preferred as investors seek protection from rising prices and as opportunity costs in terms of real interest rates move lower.

Ballooning government debt levels will also weigh on the Fed’s decision to ease as elevated interest costs further add to the US fiscal debt burden. Given the unsustainable debt dynamics and reducing appetite for US government bonds from foreign central banks, US central bank may have to absorb much of the issuance going forward, marking a U turn in their policies.

While a soft-landing scenario can be troublesome for gold, we assign a lower probability for a such a delicate balance to be achieved. Thus, it is highly probable that the Fed will either over tighten or under tighten its policy, keeping gold relevant both from a risk mitigating and return enhancing perspective.

2)      Geopolitics & Central Bank demand

With the ongoing geopolitical crises, risk assets will stay vulnerable to escalations.  As such, we can expect a structural risk premium to get embedded in gold prices.

Adverse impact of these geopolitical developments on supply chains and commodity prices will keep inflation sticky at higher levels, probably above the comfort level of central banks. Similarly, the deglobalization trend which is underway post the pandemic is also expected to keep costs of goods and services elevated. Appeal for gold, which is considered a store of value, can be expected to increase in response.

The de-dollarisation trend to diversify away from the US dollar, fuelled further by ongoing geopolitical risks, will keep pressure on the dollar and help gold. We expect strong central bank gold demand to act as a soft support for gold prices as it did in 2023.

3)      Physical demand & Indian Rupee

Physical demand from leading gold buyers India and China is expected to be healthy, keeping prices well supported. India’s economic robustness will fuel consumption demand whereas China’s economic uncertainty should drive up investment demand.

Indian Rupee isn’t expected to see any outsized movements on either side as domestic interest rates should move in line with global rates as they did in 2023, and India’s $600 bn+ forex reserves give the Indian central bank ability to manoeuvre. Crude prices too are expected to be rangebound given the global slowdown on the one hand and geopolitical flare ups and supply cuts on the other. As such impact of Indian Rupee on domestic gold price will be muted.

What should investors do..

All in all, gold can be a useful asset to hold in 2024. As interest rates peak and timing and extent of rate cuts remain uncertain, it can provide opportunity for markets to speculate, creating volatility across asset markets, including gold. Markets can oscillate between optimism and pessimism creating wild short-lived swings in gold prices on either side. Use these swings wisely to build your allocation to gold which can benefit from the eventual turn in Fed policy, that is now a given at some point next year.

SOURCE : Bloomberg , AMFI

Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.
Risk Factors: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

2024: Equity Outlook

2023 defied the consensus view of moderate equity returns given the background of rising global interest rates, limited scope for valuation expansion and elevated crude prices amid geo-political tensions. The Sensex delivered a total return of 19.1%, majorly supported by earnings growth. BSE Mid cap and BSE Small cap indices delivered returns of 44.7% and 46.7% respectively. Returns in large and mid-cap indices were majorly driven by earnings growth with flattish earnings multiple. This is indicative of the strengthening of the earnings upcycle which commenced in FY22. (Note: YTD Return figures as of Dec 15, 2023 are considered)

Key Triggers to decide market direction in 2024:

·         Demand Pickup in mass segment

Demand in mass market and rural segments remain muted since the pandemic due to inflationary pressures. A moderation in inflation could support a recovery in the mass market segment, further strengthening the ongoing economic upcycle. While the earnings growth in recent quarters was driven by margin expansion, volume growth driven by  broad-based demand could support earnings growth in 2024. Volume recovery in rural focussed two-wheeler sales indicate green shoots in rural consumption.

·         Private Capex Revival

Most of the recent capex was driven by government sector. As per RBI survey, capacity utilisation in manufacturing sector is near a healthy level of 74-75%. Buoyant demand environment along with a pickup in utilisation could strengthen the private capex trajectory. Private capex is showing early signs of revival. As indicated in the below graphs, share of private sector in new project announcements has meaningfully improved.

Private Sector Leads in New Project Announcements: