• Market has its own pulls and pressure:
Positives - Domestic Growth, Corporate Earnings, Govt. Reforms (IBC/GST etc.)

Negatives - Oil Prices, Trade wars, Withdrawal of QE, Credit Squeeze, NPA cycle, US bond yields, Valuation, Political Uncertainty

•Crude prices are surging ahead, reaching 83.02 USD per barrel at the end of September
•Depreciating Rupee is a cause of concern
•Forex Reserves Are Down US$25.6bn From The Apr’18 Peak Of US$426.1bn
•Deposit With PCA Banks Is Fast Emerging As Bottleneck For Credit Growth
•Similarly, PSU banks under PCA have seen their market share in deposits decline from 26% in FY16 to 20% in FY18, with majority of the lost market share being picked up by Private sector banks
•Midcaps and Smallcaps corrected sharply during month
•Midcap Valuations Now Approaching Parity with Large Caps
•Domestic Flows Into Equities Remain Stable. Equity buying by domestic investors supporting markets
•While Valuations Not Cheap, Patience To Be Key As We Await For Earnings To Pick Up Further

• FII Demand Weakens - USD 6.4bn has gone out of Indian debt market in FY19 compared to inflow of USD 18.5bn in FY18
•CPI Drops - CPI declined to a 10- month low 3.7% in August 2018, lower than MPC’s medium-term target of 4.0%
•Yield Sharpens - Bond market yields rise on account of depreciating rupee and increasing Brent crude prices
•Brent Crude Climbs - Brent Oil Has Biggest 2018 gain in September as Iran sanctions rattle market at ~$83 per barrel
•Trade Deficit Widening - At $17.4 billion, India’s trade deficit in August has eased from a near five-year high of $18.02 billion in July
•Falling Rupee - In six months to September, the rupee depreciated 4.09% to close at 72.49 against the US dollar
•RBI Infuses Liquidity - The Reserve Bank of India bought 100 billion rupees of bonds on 27th Sept’18. This was also the fifth such auction by RBI in this fiscal
•Fed Rate Hike - US Fed raised interest rates by 25bps from 2% to 2.25%. This is the eighth time the Fed has hiked the rate since 2015

Debt Outlook – Long End

•A depreciating INR, rising crude oil prices and global uncertainties may force the RBI to be hawkish and go for another hike to defend the currency.
•We expect headline CPI to start rising towards 4% in the coming month and then subsequently to 5%. As the monsoon was normal, we expect food supply to provide some cushion from oil price inflation
•RBI is back with OMO and has done Rs 20,000 cr OMO in Sept and has announced Rs 36,000 cr additional support in the month of Oct. We maintain that the RBI needs to do a total of Rs 200,000 cr OMO but timing and choice of stock is critical
•The Government has announced a sharp decrease in H2 borrowing program. On the other hand, RBI announced OMO calendar for the month of October worth Rs 36,000 cr which has helped the yields rally to 7.95%. We believe it will be difficult for the bond to breech 7.90% and sustain in an environment where INR is deprecating and crude is rising. The upside risk in yields is still open and clear
•Currently our portfolios contain low average maturities. This enables us to allocate in higher duration easily whenever the market may provide buying opportunities
•Over the next 6 months, markets may discount most of the negative surprises. This may eventually provide prospective buying opportunities at attractive levels

Debt Outlook – Short End

•The short term yield curve is already steep - given the uncertainty in the macro economic variable
•Less than 1 year market is pricing in a 25 basis point hike in the upcoming policy. However, if the hike is more than expected, the yield curve may flatten
•We expect the short term yield curve to flatten as 1-3 year is discounting more than 50 bps rate hike now.
However, the liquidity tightness and currency depreciation may cause some volatility. The 1-3 year curve provides adequate risk reward tradeoff.

Positive Signs:
•Domestic Growth
•Corporate Earnings
•Monsoon

Negative Signs:
•Oil Prices
•Trade Wars
•Withdrawal of QE
•US Bond Yields
•Valuation
•Political Uncertainty

Macroeconomic conditions:
•Crude is back to $77+. Crude oil imports are under US sanctions pressure, pushing up the prices
•Depreciating INR is a cause of concern. Since Jan ’18, it has depreciated by 12.6% till Sept ‘18
•Barring Autos, the current growth in most segments is at Pre-Demon level, which is subdued in business cycle context
•Domestic Consumer demand is strong
•Monsoon season rainfall for India as an average is 8% below normal
•High Frequency Indicators point to strength in Domestic Growth and Bank Credit Growth has Perked Up
•Midcaps and Small caps corrected sharply during month

Cautious Approach:
•Global Factors - Turkish Crisis, Trade Wars, High Crude Oil Prices etc.
•Fiscal deficit could be higher if: i) divestment targets of Rs.80,000 crores will not be met ii) Oil prices remain high iii) Election bound spending
•Steep Valuations
•Political uncertainty
•Indian Markets higher than most peers on valuation
•Domestic Flows Into Equities Remain Stable
•While valuations are not cheap, patience is set to be key as we await for earnings to pick up further

How August 2018 unfolded:
•GDP growth surges at an 8.2% in Q1 of 2018-19. Highest growth in two years and strongest since Q1 2016.
•CPI declined to 4.2% in July 2018, lower than market expectation
•Bond market yields rise on account of depreciating rupee and increasing Brent crude prices
•Brent Crude extends ~6% in the Aug month, due to ongoing concerns over tighter global inventories tied to U.S. sanctions on Iran.
•Sharp surge in imports led to worsening of trade deficit to $18.02bn in July’18 ($16.6bn in June’18) as against a deficit $11.45bn during July’17.
•Rupee has declined ~3.3% in August. It plunged to a fresh record of low of over 71 against US$
•Fiscal deficit has reached 86.5 per cent of the Budget Estimate.
•Foreign direct investment in India grew by 23 % to USD 12.75 billion during the April-June quarter of 2018- 19

Factors impacting the markets:
•RBI has managed to keep overnight rate close to the repo rate. As the currency is under pressure, RBI may go a little slow on the OMO purchases for adding durable liquidity. However, the overnight rate is likely to remain around repo rate
•The CPI inflation moderated sharply to a nine-month low 4.2% in July 2018 (+2.4% in July 2017) from 4.9% in June 2018 (+1.5% in June 2017)
•The core-CPI inflation remained elevated, with only a mild decline to 6.3% in July 2018 from 6.4% in June 2018; an uptick in inflation for miscellaneous items weighed against the correction in the other components
•Inflation for food and beverages eased considerably to 1.7% in July 2018 (+0.4% in July 2017) from 3.1% in June 2018 (-1.2% in June 2017), benefitting from the base effect.
•The urban CPI inflation eased to a four-month low print of 4.3% in July 2018 from 4.8% in June 2018
•The rural CPI inflation softened considerably to a nine-month low 4.1% in July 2018 from 4.9% in June 2018

Debt Outlook – Long End:
•A depreciating INR, rising crude oil prices and global uncertainties may force the RBI to be hawkish and go for another hike to defend the currency.
•We expect headline CPI to decline in the near term. Although this is subject to a normal monsoon and stability in Brent crude prices.
•There has been a pause in the OMO purchases causing further rise in yields. Going forward, OMOs are needed but the timing is uncertain, thus keeping the yields elevated. A one off OMO may cause a short rally but market needs a series of OMOs to sustain a decent rally which is unlikely in the current environment.
•The 10yr bond will have the next resistance level at 8%. A decisive break above will open up space for further strength to 8.40%. This may not be achieved in a hurry but will certainly alter the direction in the near term.
•From valuation stand point, the market is at fair levels and is largely a trading market. The market sentiments are overweighing the valuations, indicating further volatility ahead with an upward bias.
•Currently our portfolios contain low average maturities. This enables us to allocate in higher duration easily whenever the market may provide buying opportunities.
•Over the next 6 months, markets may discount most of the negative surprises. This may eventually provide prospective buying opportunities at attractive levels.

Debt Outlook – Short End:
•The short term yield curve was already steep - given the uncertainty in the macro economic variable
•As highlighted in our previous note, the short end of the yield curve may be unlikely to have an impact due to the recent rate hike. This was reflected in the yield curve in the month of August.
•We expect the short term yield curve to remain steep over the next month. However, the liquidity tightness and currency depreciation may cause some volatility

Equity Market Updates:
1. Brent Crude came dropped to USD 73.07 per barrel from USD 78.6 per barrel in the month of July 2018
2. US imposes 25% traffics on $50 billion of imports & then an additional 10% on $200 billion of imports from China, and China retaliates in kind.
3. India Pips France To Become World’s 6th Largest Economy. 10 Years Ago, India’s GDP Was Half Of France’s GDP And Now Within Striking Distance To Overtake UK.
4. Hiring Trend in Domestic Demand Driven Sectors is High. Hiring Activity sees 9% rise in June 2018 as compared to June 2017.
5. Midcaps and Smallcaps corrected sharply during the month of July
6. Domestic Flows Into Equities Remain Stable. Equity buying by domestic investors is supporting the markets.

Key Factors to watch out for:
1. Monsoon: Cumulative June-July monsoon showers have been 6% below normal.
2. Estimated 21% Earnings Growth In FY19 Would Be A Major Acceleration Over The Past Several Years


Market Performance in the last one year:
NIFTY Index - 12.3 %
NSE Midcap - 2 %
NSE Small cap - (4.6 %)
IT - 35 %
FMCG - 20.3 %
Energy - 18.2 %
Real Estate - 3.6 %
Private Bank - 11.9 %

Debt Market Updates:
1. MPC hikes repo rate by 25 basis points to 6.50%, keeps stance neutral
2. CPI rises to 5.0% in June 2018, lower than market expectation
3. Bond market Yields Soften on drop in Brent crude price and on CPI data
4. Brent Crude declined ~8% in the July monthly, largest monthly decline in 2 years
5. Trade Deficit widened to over five-year high of $16.6 billion compared to $14.62 billion in May 2018
6. PMI, rose to 53.1 in June from 51.2 in May, at the strongest pace in 2018
7. Second-quarter GDP jumps 4.1% for best pace in nearly four years
8. The Chinese economy advanced 6.7 % YOY in June. China's industrial production rose by 6 % YOY in June 2018
9. 10 year Gilt Yield became 7.7% from 7.91% in the month of July 2018
10. RBI has managed to keep overnight rate close to the repo rate. As the liquidity in the system reduces due to the increase in the Currency in Circulation, RBI may start conducting Open market operations, possibly in Q2, as against Q3 & Q4 of FY 2018-19

Debt Outlook – Long End
1. RBI hiked repo rate by 25 bps in August month. The hike was largely to anchor inflationary expectation and stem Rupee depreciation
2. We believe that the CPI has peaked at 5% on headline and is expected to decline in the near term. Although this is subject to a normal monsoon and stability in brent crude prices.
3. RBI continued the monthly trend of Rs 10000 cr OMO in July. This is likely to continue in August month as well.
4. Present gilt levels provide a real interest rate spread of more than 200 bps from peak CPI levels. At these levels, the yields may be already discounting additional 1 to 2 rate hikes (if any). However the higher oil price and Rupee depreciation remains the key source of risk
5. The 10 year bond has reached 7.70% post the rate hike and needs some large stimulus for a meaningful rally below 7.60-65%
6. From valuation stand point, the market is at fair levels and is largely a trading market


Debt Outlook – Short End
1. The short term yield curve was already steep given the uncertainty in the macro economic variable
The extreme shorter end of the yield curve up to 3 months had moved up during last week of July 2018 on account of IPO related outflow and demand for funds

• GDP Growth: India's GDP grows at robust 7.7% in Q4 of FY18, full year growth at 6.7%.
• Karnataka Elections: BJP emerged as the single largest party (104 of 222 seats). Post-election, we saw major upheaval with BJP first forming the government before subsequently the Cong-JD(S) coalition coming to power with H D Kumaraswamy sworn in as CM.
• Monsoon: The south-west monsoon hit Kerala on 29 May, 3 days ahead of schedule. India is likely to witness the third successive normal monsoon with IMD forecasting a normal monsoon at 97% of long period average.
• Trade Deficit: Apr trade deficit remained unchanged at $13.7bn, while exports expanded 5.2% YoY led by growth in engineering goods, drugs and pharma. Imports growth slowed further to 4.6% (lower than previous 7.1%).
• Inflation: CPI inflation spiked for the first time in 3 months, rising to 4.58% from 4.28% in Mar, higher than expectations. Core inflation (CPI ex-food ex-fuel) surprised with a 5.9% rise YoY from 5.4% in Mar. Wholesale prices also breached a fourmonth high of 3.18% in the month, on the back of rising crude oil and food prices.
• Indian equities moved sideways in May on the back of mixed political news, Q4 results and outflows from FIIs and FPIs.