The BSE-30 and Nifty-50 indices declined around 5% each in June, as the markets remained concerned amid monetary tightening due to elevated inflation levels and recession concerns. Brent Crude was extremely volatile and touched ~$125/ barrel before correcting ~$110/ barrel. Mid-cap and Smallcap indices underperformed large-cap and fell 6.5% and 8.3%. All sectoral indices closed negative except auto index. Metals, Consumer Durable and Realty indices were the biggest losers, declining 14%, 9% and 6% respectively.

High-frequency data for June was mixed, with expansion in service’s consumption, a mixed trend in industrial activity while external demand moderated. About the ongoing monsoon season, the IMD’s forecast for rainfall over northwest India is likely to be ‘normal’ this year, which is 92% to 108% of the Long Period Average. In June, the Central Government, hiked the minimum support price (MSP) for 14 kharif crops, ranging from 4% to 8%. On the taxation front, Govt has levied export tax on petrol, diesel, and windfall tax on domestic crude oil production. During the month, FPIs sold US$ 6.4 bn worth of Indian equities in the secondary market while DIIs bought US$5.9 bn.

Globally, economics continues to influence investor behaviour across markets and the battle to tame inflation dominates the agenda of most authorities and central bankers. From an India perspective, the sharp decline seen in various soft and hard commodity prices in the past few weeks along with continuing intervention of Indian policy makers would accelerate the process of inflation normalization. Inflation expectations in India can also be expected to moderate with improving trends in the progress of the monsoon. India’s monetary and fiscal policy co-ordination will likely allow the RBI to reach neutral much sooner, thereby taking the risk of structurally higher inflation and/or significant deterioration in the growth outlook, off the table.

However, the battle on inflation in developed markets may be quite prolonged though recent trends in commodity prices should bring relief there as well. This may also delay the eventual recovery of the domestic markets until peak inflation in developed markets is decidedly behind, and growth slowdown/recession concerns have fully played out. At a broader level, a portfolio tilted towards domestic growth stories will likely work out better relative to global sectors. After a brief hiccup due to the Russia-Ukraine conflict, our long-favoured preference towards sectors and companies that are users of commodities v/s producers of commodities is now starting to play out strongly and is expected to extend itself for some more time. While globally exposed sectors like IT and metal/oil commodities have now turned lot more palatable in recent weeks on valuations, we remain watchful and wait for probable moderation in earnings expectations.

The upcoming result season for 1QFY23 will likely hold important clues with regards to growth and profitability trends across a swath of industries and will be the cynosure of the market for the coming month. We continue to believe that India’s overall profit pool has reasonable resilience to the current inflation shock and should not see material downgrades hereon. Market valuations are now at or marginally below its 5-yr average and not too far out even from 10-yr averages. The ongoing uncertainty, particularly around the world economy will keep equity market returns on leash for most part of 2022. However, we stay constructive on India’s improving economic cycle and inherent stability and believe the balance of this year will provide good opportunities at portfolio and investment planning for potential returns during 2023 and beyond.

Global Financial markets witnessed wide oscillations during the month as the market participants struggled to weigh the inflationary pressures vs the recession fears in few developed economies. Domestic interest rates also saw high volatility, though to a lesser extent with 15-20 bps hardening in first half of the month before cooling off almost entirely in 2nd half as the global metal commodities corrected sharply on the back of global recessionary fears.

Domestic inflationary pressures remained high as reflected in May CPI inflation at 7.04%, though it moderated from 7.79% in the previous month on account of favorable base effect and sequential slowdown in core inflation.

RBI further hiked the policy repo rate by 50 bps in continuation to its focused shift from growth supporting policy to an inflation controlling one. Elevated inflationary pressures led by global commodity price surge including food items prompted RBI to sharply revise the inflation projections upwards to 6.70% for FY23, from 5.70% projected in April’2022 and 4.50% projected in February’2022.

FPI’s continued to sell off in both debt (~INR 24bn) as well as equity (~INR 495bn) amidst global risk-off sentiment triggered by elevated inflation fears and aggressive monetary tightening. INR depreciated sharply during the month to close at 78.97 on month end against USD, as EM currencies came under pressure as USD strengthened on expectations of aggressive US FED rate hikes.

Outlook

CY22 is expected to remain volatile as globally the Central banks go for aggressive rate hikes to rein in inflationary pressures, which may also raise the recessionary fears forcing Central banks to slow down later and settle at lower than currently expected terminal policy rates. We believe that inflation trajectory is uncertain on geo-political risks and quantum of the rate hike by US FED and as such is expected to remain elevated, especially over next few months on energy prices. On the domestic front, notwithstanding the recent correction on metal commodities and benign monsoon outlook, next few months remain very critical for inflation trajectory.

MPC has clearly articulated a pivotal shift away from ultra-accommodation adopted during pandemic and with inflationary pressures still remaining elevated, we expect MPC to continue with rate hikes over next few policies to reach ~5.75% to 6% Repo rate by April 2023. Further rate hikes, if any will depend upon the expected inflation trajectory in FY24, which is still evolving and dependent on geo-political uncertainty.

Besides the inflationary pressures, incremental drag on Balance of Payment due to high Current Account Deficit and FPI’s sell off can add to the complications for RBI for maintaining healthy Forex Exchange cushion and currency stability.

With challenging global backdrop as many Central Banks tightens the monetary policies to tame inflationary pressures, huge fiscal supply and RBI’s expected fast withdrawal of ultra-accommodative policy, we expect interest rates to remain volatile with an upward bias.

We feel that 6 months to 1 year segment of the yield curve provides an opportunity to risk-averse investors amidst uncertainty going forward. For investors looking at the core allocation, the 1 to 3 year segment of the yield remains well placed from carry perspective as it has already priced in more aggressive rate hikes. This segment is a sweet spot on the yield curve – neither too short which gets impacted by low gross yields, nor too long that can get impacted by the rate volatility.

Credit environment remains healthy; however, current narrow spreads of AA / AA+ over AAA bonds do not provide favorable risk adjusted reward opportunities, and we expect illiquidity premium to increase sharply over a period of time thereby posing mark to market challenges for this segment.