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Explained: Inflation softening, what now?

US inflation cooled unexpectedly in July, boosting markets around the world. The worst may be over, but the RBI and Fed remain cautious. Investors can look at equities, but a staggered approach is advisable

Despite the easing of inflation in India and the July softening in the US, both RBI and Fed officials have maintained that price pressures continue, and that there could be more rate hikes in line with inflation levels. (Reuters/File)

Lower-than-expected United States inflation data at 8.5 per cent in July, down from the 9.1 per cent of June, has generally boosted investor sentiment around the world. Indian markets were already drawing comfort from softening crude oil prices and overall inflation, and were on the rise.

However, experts say that inflation remains a concern, and central banks may continue to raise rates — which could impact demand and the margins and share prices of companies. They, therefore, call for a step-by-step deployment in equities.

US numbers boost

As US inflation cooled in July, equity markets witnessed a relief rally. The Dow Jones Industrial in the US rose 1.6 per cent to close at 33,309 on Wednesday, and Asian markets traded strong on Thursday — with the Hang Seng in Hong Kong and Shanghai Composite in China rising 2.4 per cent and 1.6 per cent respectively. Markets in Europe traded flat on Thursday.

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In India, the benchmark Sensex at the Bombay Stock Exchange rose 0.9 per cent to close at 59,332, the highest in four months. Since June 17 — when the Sensex closed at 51,360, the lowest since May 2021 — the index has risen 15.5 per cent, inching close to 60,000.

The return of FPIs

While softening crude prices and easing inflation have brought comfort, positive FPI flows over the last month have supported the markets — alongside continuing domestic retail inflows through mutual funds and direct investments.

FPI inflows turned positive in July — for the first time since September 2021 — with a net inflow of Rs 4,989 crore. In August, they have already pumped in a net of Rs 20,204 crore. Between October 2021 and June 2022, FPIs had pulled out an aggregate of Rs 2,55,879 crore from Indian equities.

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Inflows from DIIs, who invested a net of Rs 3,08,772 crore between October 2021 and July 2022, have provided  strong support. August, however, has witnessed some profit-booking following the sharp recovery in markets, and DIIs have seen a net outflow — Rs 3,404 crore till date — for the first time in 11 months.

US inflation over the decades

“DIIs holding up goes beyond the conventional dimension of Indian markets which used to fall significantly when FPIs pulled out, and rose when they came back. This time domestic investors have absorbed most of the stress of FPI outflows, and Indian retail investors have gained muscle in terms of technicals,” C J George, MD, Geojit Financial Services, said.

Monthly net investment in equities; movement of Sensex

Shrikant Chouhan, Head of Equity Research at Kotak Securities, said: “Investors cheered the US inflation data for July, which came in below the estimate and raised hopes that the Federal Reserve may not be that aggressive in hiking interest rates in its next meeting. Traders have also drawn comfort from falling crude prices and FII inflows into local shares over the last few sessions.”

What has changed?

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While inflation has been the top concern around the world over the last four-five months, there has been a visible softening of late. Brent crude prices have fallen from around $110 per barrel in March-April to under $100 now. Global commodity prices and food prices that shot up after the war in Ukraine began, have also softened.

In his monetary policy statement recently, RBI Governor Shaktikanta Das said that domestic edible oil prices were expected to soften further on the back of improving supplies from key producing countries, and supply-side interventions from the government. “The resumption of wheat supply from the Black Sea region, if it sustains, could help to temper international prices. Supply chain pressures, though elevated, are on an easing trajectory,” he said.

The RBI has maintained that inflation has peaked and household inflation has eased; however, it still remains at unacceptably elevated levels.

Should you invest now?

The decline in US inflation numbers in July is reassuring for the markets. While company margins will be impacted in the second quarter by the higher interest rates, experts feel that the market may not come down as a result — because of a sense that both inflation and rate hikes have peaked and things will start improving beginning the third quarter of the financial year.

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“Even as markets have risen, I think investors can enter or continue to invest in equities. They must, however, follow a staggered approach, or do it through SIPs, as we are still not seeing a very firm trend, and there are geopolitical and global inflation concerns still around,” George said.

There are some who feel that the Indian markets could witness sustained growth over the medium term on the back of potential economic activity. “Credit growth is rising, companies in key sectors are preparing to invest, and the Indian economy could benefit from the global supply chain diversification strategy. All these may lead to higher growth in the medium term, and investors could enter with a medium- to long-term view,” the CIO of an asset management firm said.

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What are the concerns?

Despite the easing of inflation in India and the July softening in the US, both RBI and Fed officials have maintained that price pressures continue, and that there could be more rate hikes in line with inflation levels.

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Earlier this month, announcing a 50 basis point hike in the repo rate, the RBI Governor said: “The MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium term. [It] therefore judged that further calibrated withdrawal of monetary accommodation is warranted to keep inflation expectations anchored and contain the second-round effects. Accordingly, [it] decided to increase the policy repo rate…”

Market experts also remain wary of the geopolitical situation. Russia and Ukraine continue to be at war, and there are renewed concerns over China-Taiwan tensions following the visit of the Speaker of the US House, Nancy Pelosi, to the island.

First published on: 12-08-2022 at 04:03:39 am
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