Markets have started to price in a higher recession probability: Anurag Mittal, UTI MF

Mittal expects the RBI to cut rates up to 75 bps in the next 6-12 months. Given the sticky domestic inflation, he sees BOJ gradually tighten the monetary policy

Global equity markets were rattled recently by the possibility of a recession in the United States even as the Bank of Japan (BoJ) hiked rates to the highest level in the last 25 years. ANURAG MITTAL, head of fixed income at UTI Mutual Fund, tells Puneet Wadhwa in an email interview that apart from liquid funds, high quality moderate duration products (one-four years) are better suited for investors that wish to invest for the long-term. Edited excerpts:

How do you see bond yields play out in the next three - six months in case the 'higher for longer' narrative for central banks, especially the US Fed and the RBI holds true?

 

Current bond valuations are not pricing in a ‘higher for longer’ scenario and yield may come under pressure in case monetary easing gets delayed. The balance of risks to growth has increased with global consumption expected to weaken on restrictive interest rates, fading fiscal stimulus, and exhausted savings.

Given the slowing economic trajectory and comfortable inflation, we expect the US Federal Reserve to start cutting rates by 150 – 200 basis points (bps) at a minimum in this monetary cycle starting from September 2024. 

While global markets have started to price in the expected Fed’s reaction function, we expect the Reserve Bank of India (RBI) to cut rates once they have greater confidence on stability of inflation or slowdown in growth. We expect 50-75bps of rate cuts by RBI in the next 6-12 months. 

What's your take on the possibility of the US getting into a recession? To what extent are the financial markets pricing this in?

Markets have recently started to price in a higher probability of recession and more aggressive rate cuts by the Fed driven by weak labour data. Swaps are pricing in more than 100bps rate cuts in calendar year 2024 (CY24) compared to just 50bps at the end of June. While wages are slowing down, the labour market is still relatively healthy and supportive of consumption.

Our base case remains a slowing growth momentum rather than an outright recession. We are not seeing acute distress in financial conditions or labour markets generally associated with recessions. Central banks are expected to remain on a gradual easing path as growth and inflation moderates in an orderly transition.

Assuming this recession does happen, how do you think the global central banks will react to such a situation? What's the first line of defence?

Central banks’ reaction function will depend on the type of recession. An economic recession sparked by a weak housing or labour market could lead to asymmetric and sharper interest rate cuts from global central banks, as interest rates aren’t close to zero today in contrast to the pre-pandemic era.  A recession caused by financial market instability, however, may require targeted measures like forex (FX) / liquidity lines or asset purchase programs, apart from regulatory measures to contain volatility.

Is the Bank of Japan (BoJ) done with rate hikes for now?

Given the still sticky domestic inflation, we expect BOJ to continue to gradually tighten monetary policy. While asset markets may fluctuate in the near term depending on the market’s pricing of Fed rate cuts, the emphatic Yen appreciation has already built in substantial rate hikes from the BOJ. A significant Yen appreciation from current levels may not be possible unless BOJ undertakes extremely aggressive rate hikes, which is not our base case.  

How much inflow do you expect in the long duration bond funds in the next two quarters back home given the narrative on interest rates?

Real interest rates are meaningfully high in India compared to the last three years, which present an attractive opportunity for patient investors. We have already seen flows in excess of Rs 15,000 crore in gilt and long-duration funds since March 2023. We continue to expect to see meaningful flows in high duration categories on the prospect of rate cuts.  

Which category of debt funds should one latch on to now?

Apart from liquid funds which serve immediate liquidity needs, high quality moderate duration products (one-four years) are better suited for investors over long-term horizons. Interest rate cycles can be volatile and moderate duration products can provide reasonable accrual as well as opportunity to participate in capital gains without taking very high duration risk.