Are the markets ignoring the possibility of higher inflation?

Globally, too, sticky inflation seems to be a cause for concern. Last week, two Federal Reserve (US Fed) officials suggested that the US central bank may need to keep interest rates elevated ahead

Elevated food price-led inflation could become a sore point for markets going ahead, which they seem to be ignoring at the current levels, said analysts. Retail inflation in India – as measured by the consumer price index (CPI) – came in at a three-month high of 6.52 per cent in January 2023 as compared to 5.72 per cent in December and 5.88 per cent in November 2022.

The inflation print for February, according to Madan Sabnavis, chief economist at Bank of Baroda, will be critical for the Reserve Bank of India's (RBI's) monetary policy committee (MPC) because if it remains above 6 per cent, there could be room for debate on a further rate hike.

“The market is not rejecting the view of another rate hike in the coming months, though it is agreed that the decision will be data driven. The CPI inflation number has stoked some debate on high cereals inflation driven by wheat where the NSO has adjusted some weights given that the PDS part now does not have a cost; hence, there has been a loading of this weight on free market prices. But we believe this will account for not more than 0.2 per cent variation. Inflation will still be at 6.3 per cent or thereabouts,” Sabnavis said.

Another worry on the inflation front is the possibility of a sub-par monsoon season in 2023. The National Oceanic and Atmospheric Administration (NOAA) – the US government’s weather agency – has indicated the possibility of an El Niño in 2023, which means less than normal rains. This, analysts said, can impact sowing and thus result in lower crop yields in India, thereby hurting farm incomes and stoking inflation.

“The last El Niño event was in 2018, which coincided with below-normal rainfall in India. Since then, India has witnessed four successive good monsoons. Given the backdrop, the probability of a fifth normal monsoon appears faint at this stage. Clarity usually emerges only around April-May,” wrote Abneesh Roy, Rushabh Bhachawat and Jainam Gosar of Nuvama Research in a recent report.

Pan-India rainfall in fiscal 2022-23 (FY23), according to Nuvama analysts, was around 6 per cent higher than the long-term average rainfall. Yet, populous states such as Uttar Pradesh (UP), Bihar, Bengal and Jharkhand reported a deficit, affecting paddy sowing.

Globally, too, sticky inflation seems to be a cause for concern. Last week, two Federal Reserve (US Fed) officials suggested that the US central bank may need to keep interest rates elevated going ahead in order to tame inflation.

The likely hawkish stance from the US Fed, according to V K Vijayakumar, chief investment strategist at Geojit Financial Services, will restrain the rally in the US markets and this will also keep the Indian market in a range, attracting selling at higher levels and buying at lower levels.

As an investment strategy, select bank stocks, large-cap information technology (IT) and stocks of capital goods companies, he suggests, are reasonable now post the recent correction and may be accumulated on declines.

“There is a growing concern that the equity markets are ignoring the risk of high inflation, which is declining only very slowly. Comments from some Fed officials that they might have to remain hawkish for an extended period of time and might support even a 50 basis point (bp) rate hike in March Fed meet are negative for equity markets,” he said.