Do tell us in your understanding right now if these sustained levels of spikes that we are seeing as far as the 10-year US treasury yields are concerned, do you think those are going to remain at elevated levels and if so, is money going to get pulled out of emerging markets like India? What is your reading?
I think the answer to those two questions are yes and no. First of all, I think it is just that bond yields are going to stay relatively high for a while. They have gone up sharply as everybody knows in the last few months, including in August itself. You put that down to two things. First of all, the persistence of a reasonably robust economy in the US, where we do not seem to be getting this soft landing or the fear of recession has subsided, perhaps that is a better way to put it and that is pushing bond yields up. Also, there is a renewed worry about supply because, of course, of the very wide US budget deficit. So, I think it is a combination of those two. Now, this is a global phenomenon. Of course, the US bond yields may be leading the way, but in this environment where the fundamentals in India are very strong, indeed, as far as I am concerned, I think a lot of global investors feel that, especially with all the problems that China is having. I do not see this leading to a major-major outflow of foreign money from India at this stage.
Do you think that anything that Jerome Powell would say at the Jackson Hole summit is going to change the course, as it were, of the markets? Will he pronounce a statement that may even suggest any decision on rates that may not be data dependent? Is that a likelihood even?
I doubt it. I think he is not, because he typically does not opine on the short-term outlook for interest rates, because what everybody wants to know, of course, is — are we at the peak? Is there one more to go? Is there two more to go, whatever? My own gut feel is that we are either at the peak or there may be one more to go.
I think what is more likely, he is going to emphasize the need for inflation eventually to return to 2% which, by the way, is not going to happen in the second half of 2023.
I have argued for some time that June may well have been the trough for inflation, year-on-year headline at 3%. We already see it tick up a little bit in July. So, if the 2% goal is really what Chairman Powell wants to focus on, we have got to look for that move towards 2% to happen, if you like, early next year or in the first half of next year. So, I think he is going to be sketching more of a long-term outlook and the importance of the 2% inflation target rather than giving us a real steer, if you like, on what may happen at the next meeting.
He is going to stay tough in the sense that he is going to say there has been a lot of progress on inflation coming down, but the job is not finished and that possibly implies perhaps one more rate hike. Going by the inflation print of late, the kind of stance that the Fed has upheld, indeed the resilience of the American economy as well, which is in a sense good for the global economy, how do you think bond yields are going to move in the near term? Will they stay at the elevated levels that they are and how is that going to play out on the US dollar which seems to be losing some steam of late against peers and definitely against the Indian rupee as well?
Well, I am not sure that is right, because in fact, we were looking at the dollar quite a bit weaker than it is today.
Just several weeks ago, it rallied quite a bit of late on the back of the rise in US bond yields and indeed the expectation the Fed may have more to do and I think this is complicating the emerging market story because obviously, as I have argued many-many times the EM does not tend to attract money when the dollar is strong and you have just gone through eight successive down days for emerging market and the emerging market index, of course, not helped by the big problems that are in China.
Now, I think we do get some definitive evidence shortly that the Fed is done in terms of interest rate hikes, which I think is probably going to be the case at some point over the next two to three months or so and there is a prospect of lower inflation in 2024, I think the bond yield increase will taper off and then you will probably see money coming back into the emerging markets.
So, I am still bullish about EM here because we have had a big sell-off. This is a good entry point.
But I think the decline in yields that will come eventually is probably a few weeks or even a few months down the road and I think yields stay high for now until we get a better idea of when inflation really will come down further and when the Fed is finished with its tightening.