US inflation hit a 40-year high of 8.6 percent in May, which made global markets cautious on expectations the Federal Reserve would go for a more than 50 basis point hike in the funds rate. There was a sharp correction in the previous two trading sessions as the 10-year US bond yield jumped to 3.37 percent, while the 2-year US treasury yield was 3.28 percent.
The inversion is getting sharper and that signals an upcoming recession. With the current data set, avoiding a recession in the US looks more difficult, Sameer Kaul, MD & CEO of TrustPlutus Wealth (India), said in an interview to Moneycontrol.
For equity, he said the second half of 2022 could be better than the first. Edited excerpts:
Is inflation yet to peak considering the current macro environment? Also, is 7 percent consumer inflation manageable for India?
At present, inflation is a result of high crude and food prices. There is a constant fall in global crude production due to the impact of ESG (environmental, social, and governance) investing over the last decade, which is keeping the price of crude high. Food supplies are also tight due to many reasons – impact of global warming, breakdown of supply chains, self-protective actions by producing countries etc., which also results in high prices for food.
This precarious situation has become worse due to the Ukraine war. Russia is a top producer/exporter of crude and gas and is severely constrained in meeting its potential. Russia and Ukraine account for nearly a third of global wheat and barley and two-thirds of the world’s export of sunflower oil used for cooking.
Ukraine is the world’s No. 4 corn exporter. The conflict has damaged Ukraine’s ports and agricultural infrastructure and that is likely to limit the country’s agricultural production for years. Therefore, this inflation could continue for some more time.
We will start getting a positive base effect towards end-2022, which will optically moderate inflation somewhat.
In this environment, India is also placed in a tight spot, but there are some silver linings. India is a major producer of food, so to that extent, food security is better assured. We have gaps in our food basket in produce like palm oil, lentils etc., but on balance, we do produce much of what we consume. However, we are mostly dependent on imports to meet our fuel requirements, and to that extent, we have an inflation impact which is severe.
The market remained volatile this year and bears have the upper hand. What is your advice to investors? How can one make an inflation- and recession-proof portfolio?
It is important to follow a disciplined asset allocation model that is tailored to your risk profile. Many of the decisions that are precipitated due to asset allocation go a long way to support your portfolio through inflationary and recessionary periods.
For example, an asset allocation model would have prompted reduction in equity weights through 2021 by booking profits to bring it in line. The same model would prompt buying now to rebalance weights. Markets are cyclical and swing between greed and fear. This is a simple way for an investor to avoid mistakes.
Do you expect a hawkish stance from the Federal Reserve on Wednesday after inflation came in at a 40-year high of 8.6 percent in May? Is there any possibility of a more than 50 bps hike in the Fed’s funds rate this week?
At this point, the dilemma of the Federal Reserve will be to assess the damage that inflation will bring about in the time that they take to raise rates as per their monthly meeting schedule. Whether anything is to be gained by shocking the market with a larger-than-expected rate hike is another question.
Even more so, the question remains how much can rate hikes alone do. More substantive liquidity-tightening measures have to be taken. Then again, if the US Fed does reduce liquidity by $ 1 trillion in 2022, then prices across assets will fall, which in turn will lead to challenges of solvency of market participants. Clearly, there are no good answers. One possible scenario will be two steps back, one step forward by the US Fed.
Is there a higher possibility of recession in the US, especially after considering inflation for May and recent consumer sentiment data? What is the message you are getting from US bond yields?
The inversion in 2-year and 10-year is getting sharper – that signal flashing a recession coming in the future. With the current data set, avoiding a recession in the US looks more and more difficult. The Federal Reserve has stated their desire to engineer a soft landing, but given their determination to tame inflation, there could be a recession in the US.
Is there any possibility of the market closing 2022 with a positive bias, considering the current macro environment – so far we are down around 9 percent?
Well, there are still six months to go and things change. The earnings momentum over the last few years has been strong. If the US Fed Reserve pauses their liquidity-tightening programme and there is a move away from the dollar towards emerging markets, there is a chance that the second half of 2022 may be better.
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