<p>Jerome Powell, the President of the US Federal Reserve (Fed), is currently grappling with what is perhaps the most delicate set of circumstances he may have to direct in his professional career. With mixed messages emanating from equity and bond markets, the Fed has to implement a delicate balancing act. 10-year US bond yields, at the time of writing this piece, stood at 4.71%, versus 5.6% for a three-month paper. This represents an inverted yield curve, where bonds of lengthier maturities provide lower returns, reflecting investor expectations for a decline in long-term interest rates. The fact that markets are uncertain, is evident considering both short-term fluctuations and the long-term downward trend of yields of US government bonds. As we head towards IMA India’s Annual CEO Roundtable Conference in December, where a more comprehensive discussion will take place, this paper will provide a brief picture of the evolving economic and business environment.</p><p>US debt currently stands at USD 33 trillion and is rising every month. This cannot constitute good news. At these levels, inflation becomes sticky and, consequently, interest rates will remain high, a situation very different to the previous decade when money was literally free. Basically, the Fed has few good choices and the most viable option is to engineer a recession and do this in a manner which economists call a soft landing. The Fed predicts that America’s economy will grow at 1.5% this year, a modest but positive pace. Interestingly, labour markets still remain resilient, with the unemployment rate varying between 3.5% to 3.8%. America continues to create, on average, 250,000 jobs each month.</p><p>Whilst these indicators present a robust picture, there are underlying trends that are not as promising. Property markets have peaked and housing starts are declining. Understandably, analysts are sceptical that the US can maintain economic output with interest rates so high. 2024 will involve a shallow recession, perhaps in H1. The pause on student loan repayments ended a few weeks ago, placing an additional financial burden on millions of American families. According to the Conference Board, US consumer spending will drop by approximately 1.1% during 2024. Softening consumption together with rising interest rates are beginning to weigh on US business investments.</p><p>Inflation is typically a symptom of an overheating economy and that is why the Fed has been raising interest rates over the past 18 months. The only alternative to an engineered recession is a hard landing for the economy, which is terrible news for stock markets and employment. At 5.5%, interest rates are at their peak in over two decades. The way things look, is that a recession should happen by the middle of next year, and interest rates should begin to decline to an average of 3.9% in 2025 and 2.9% in 2026. Be that as it may, it would be senseless to rely too heavily on these projections, given how rapidly economic circumstances could change between now and then.</p><p>The rest of the world is in much worse shape than America. The 20-member block, comprising the European Union, is likely to grow at 0.8% this year. Inflation remains persistent, consumer spending is down and Germany, Europe’s largest economy, is already in recession. It will contract by 0.5%. Others, such as Italy and the Netherlands, will grow but more slowly.</p><p>China is currently suffering the ‘Japan syndrome’ with low inflation, rising unemployment and collapsing property markets. Some of the largest home developers have defaulted on their debt obligations and many more are expected to do so in the months ahead. China’s exports have been falling for the past few months, and according to the World Bank, its economy will grow at 5% this year and possibly 4.2% in 2024. All in all, China defied expectations and failed to recover post-COVID.</p><p>Financial markets appear to be disconnected from the real economy. Despite the fact that national output continues to decline across the world, equity markets are sprinting in the opposite direction. Therefore, it would seem reasonable to suggest that a correction should take place, starting with America and, as always, spreading across the rest of the world.</p><p>For now, India is on a fine path with robust tax collections, private capital and consumption. The real worry, going forward, is likely to be the behaviour of commodity markets, specifically oil. With the recent conflict in the Middle East, oil markets are justifiably touchy. Crude prices have rallied in Q3, touching yearly highs on both Brent and West Texas. Should the Israel-Palestine conflict extend into Lebanon and Iran, oil punters will panic and possibly 3 to 5 million barrels would evaporate from the market. Crude could then touch USD 130 to 140 a barrel.</p><p>This would have an impact on India. A simple arithmetic would suggest that when oil rises by USD 10 per barrel, it has an impact of 0.2% on GDP growth. As things stand, equity markets are racing ahead of GDP growth and it is possible that a correction will take place over the coming months. However, it is the view of IMA that when this happens, it would be shallow followed by a gradual recovery. But for now, things are perky. The Reserve Bank has done a marvellous job in reigning in inflation and the government’s industrial policy, focusing on the supply side, has paid off. Inflation expectations are low, and foreign exchange reserves are strong. The explosion in infrastructure investments in areas such as power, mining, railways, roads and airports, is beginning to improve productivity. Non-performing assets within the banking system are now, by and large, fully recognised. It would be reasonable to say that the banking system has never been in better form in the past three decades. The digital India stack, currently publicly owned, has enriched the lives of citizens with rapid improvements in the delivery of government services. This could at a later date be monetised at exorbitant valuations bringing a bonanza for the treasury.</p><p>It therefore realistic to suggest that after several decades, India has moved on to the fast lane. Out of the world’s 10 fastest-growing cities, 6 are located in India. Unlike most Western countries and China, where it takes 4 dollars of debt to create 1 dollar of growth, in India the ratio is a more reasonable 1:1, suggesting greater levels of efficiency. Despite all of this, India still remains unable to attract, the sought-after, sizeable foreign investment, which is moving to markets such as Vietnam and Mexico. In response the government has and will continue to impose import restrictions to cajole companies into local production. In the longer term, several challenges remain, but it would be fair to suggest that India’s economy is now in a better place than ever to face them. Clearly, political uncertainties post elections could send all of this for a toss but for now markets, consumption and investment are poised to rapidly blossom.</p>
<p>Jerome Powell, the President of the US Federal Reserve (Fed), is currently grappling with what is perhaps the most delicate set of circumstances he may have to direct in his professional career. With mixed messages emanating from equity and bond markets, the Fed has to implement a delicate balancing act. 10-year US bond yields, at the time of writing this piece, stood at 4.71%, versus 5.6% for a three-month paper. This represents an inverted yield curve, where bonds of lengthier maturities provide lower returns, reflecting investor expectations for a decline in long-term interest rates. The fact that markets are uncertain, is evident considering both short-term fluctuations and the long-term downward trend of yields of US government bonds. As we head towards IMA India’s Annual CEO Roundtable Conference in December, where a more comprehensive discussion will take place, this paper will provide a brief picture of the evolving economic and business environment.</p><p>US debt currently stands at USD 33 trillion and is rising every month. This cannot constitute good news. At these levels, inflation becomes sticky and, consequently, interest rates will remain high, a situation very different to the previous decade when money was literally free. Basically, the Fed has few good choices and the most viable option is to engineer a recession and do this in a manner which economists call a soft landing. The Fed predicts that America’s economy will grow at 1.5% this year, a modest but positive pace. Interestingly, labour markets still remain resilient, with the unemployment rate varying between 3.5% to 3.8%. America continues to create, on average, 250,000 jobs each month.</p><p>Whilst these indicators present a robust picture, there are underlying trends that are not as promising. Property markets have peaked and housing starts are declining. Understandably, analysts are sceptical that the US can maintain economic output with interest rates so high. 2024 will involve a shallow recession, perhaps in H1. The pause on student loan repayments ended a few weeks ago, placing an additional financial burden on millions of American families. According to the Conference Board, US consumer spending will drop by approximately 1.1% during 2024. Softening consumption together with rising interest rates are beginning to weigh on US business investments.</p><p>Inflation is typically a symptom of an overheating economy and that is why the Fed has been raising interest rates over the past 18 months. The only alternative to an engineered recession is a hard landing for the economy, which is terrible news for stock markets and employment. At 5.5%, interest rates are at their peak in over two decades. The way things look, is that a recession should happen by the middle of next year, and interest rates should begin to decline to an average of 3.9% in 2025 and 2.9% in 2026. Be that as it may, it would be senseless to rely too heavily on these projections, given how rapidly economic circumstances could change between now and then.</p><p>The rest of the world is in much worse shape than America. The 20-member block, comprising the European Union, is likely to grow at 0.8% this year. Inflation remains persistent, consumer spending is down and Germany, Europe’s largest economy, is already in recession. It will contract by 0.5%. Others, such as Italy and the Netherlands, will grow but more slowly.</p><p>China is currently suffering the ‘Japan syndrome’ with low inflation, rising unemployment and collapsing property markets. Some of the largest home developers have defaulted on their debt obligations and many more are expected to do so in the months ahead. China’s exports have been falling for the past few months, and according to the World Bank, its economy will grow at 5% this year and possibly 4.2% in 2024. All in all, China defied expectations and failed to recover post-COVID.</p><p>Financial markets appear to be disconnected from the real economy. Despite the fact that national output continues to decline across the world, equity markets are sprinting in the opposite direction. Therefore, it would seem reasonable to suggest that a correction should take place, starting with America and, as always, spreading across the rest of the world.</p><p>For now, India is on a fine path with robust tax collections, private capital and consumption. The real worry, going forward, is likely to be the behaviour of commodity markets, specifically oil. With the recent conflict in the Middle East, oil markets are justifiably touchy. Crude prices have rallied in Q3, touching yearly highs on both Brent and West Texas. Should the Israel-Palestine conflict extend into Lebanon and Iran, oil punters will panic and possibly 3 to 5 million barrels would evaporate from the market. Crude could then touch USD 130 to 140 a barrel.</p><p>This would have an impact on India. A simple arithmetic would suggest that when oil rises by USD 10 per barrel, it has an impact of 0.2% on GDP growth. As things stand, equity markets are racing ahead of GDP growth and it is possible that a correction will take place over the coming months. However, it is the view of IMA that when this happens, it would be shallow followed by a gradual recovery. But for now, things are perky. The Reserve Bank has done a marvellous job in reigning in inflation and the government’s industrial policy, focusing on the supply side, has paid off. Inflation expectations are low, and foreign exchange reserves are strong. The explosion in infrastructure investments in areas such as power, mining, railways, roads and airports, is beginning to improve productivity. Non-performing assets within the banking system are now, by and large, fully recognised. It would be reasonable to say that the banking system has never been in better form in the past three decades. The digital India stack, currently publicly owned, has enriched the lives of citizens with rapid improvements in the delivery of government services. This could at a later date be monetised at exorbitant valuations bringing a bonanza for the treasury.</p><p>It therefore realistic to suggest that after several decades, India has moved on to the fast lane. Out of the world’s 10 fastest-growing cities, 6 are located in India. Unlike most Western countries and China, where it takes 4 dollars of debt to create 1 dollar of growth, in India the ratio is a more reasonable 1:1, suggesting greater levels of efficiency. Despite all of this, India still remains unable to attract, the sought-after, sizeable foreign investment, which is moving to markets such as Vietnam and Mexico. In response the government has and will continue to impose import restrictions to cajole companies into local production. In the longer term, several challenges remain, but it would be fair to suggest that India’s economy is now in a better place than ever to face them. Clearly, political uncertainties post elections could send all of this for a toss but for now markets, consumption and investment are poised to rapidly blossom.</p>
