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SPI Management Newsletter 03.11.23

A Turn in Bond Yields Signposts a Departure from the 'New Normal'


Forecasting the moment when markets react to economic forces remains a challenge as the economic shifts take time to manifest and then occur more rapidly than anticipated.


The landscape is changing as major trends that defined the past era are ending. The 'new normal'—a period post-financial crisis characterized by low inflation and historically low-interest rates—is concluding. The cost of borrowing is climbing beyond the economy's growth potential, leading to a worrying cycle of increasing budget deficits and expensive debt refinancing.


The Federal Reserve, once a predictable source of economic stabilization through rate cuts, is now constrained by high inflation, making its previous intervention methods obsolete.


Internationally, the shift in China's economic policy away from a market-driven approach towards state-led growth and security is likely to decelerate its economic momentum and reduce its influence on global inflation and investment flows. Additionally, the return of pronounced geopolitical conflicts disrupts the peaceful narrative that emerged at the end of the Cold War, paving the way for higher inflation and wider deficits globally.


The recent surge in long-term interest rates serves as an indicator of these shifts. The term premium, which investors demand for long-duration assets, has reversed its long-term decline. This change is due to several factors that have now diminished: low inflation expectations, the extensive quantitative easing by the Fed and other central banks, and the role of bonds as a hedge against stock volatility.


Investors are entering an era of the 'new abnormal,' where higher, more erratic inflation and structurally increased interest rates are the norms. The period following the financial crisis, with its exceptionally low rates, now seems an extraordinary chapter in economic history. As investors navigate this altered terrain, the lack of monetary and fiscal safety nets necessitates a new strategy for managing investments.


Charting a Course for Sustained Economic Triumph in India


The Indian economy is currently flourishing, with its recent reforms ushering in a phase of robust growth. Nevertheless, there's a precarious balance to maintain as potential pitfalls could derail the nation's prosperous trajectory.


India's economic landscape looks promising, with forecasts suggesting it might soon match the economic heft of the United States. Political stability, a youthful workforce, and a burgeoning middle class have all played their parts in attracting foreign investors and manufacturers seeking alternatives to China.


Prime Minister Narendra Modi's government has capitalized on this momentum with significant reforms, such as the national goods and services tax to facilitate interstate commerce and improved labor laws. Infrastructure has seen considerable improvements, and macroeconomic policies are commendably robust. The Reserve Bank of India's oversight has ensured a stable banking system, while government efforts towards fiscal prudence are commendable.


Perhaps the most revolutionary change has been the widespread digitization of the economy, making financial transactions and government aid more efficient and transparent.


However, projecting India's growth into the future comes with challenges. Infrastructure, though improved, still lags behind what's needed for a strong manufacturing sector. The education system isn't fully preparing the workforce for the demands of modernity. Additionally, job growth has not kept pace, and corruption remains an obstinate barrier to broader economic vitality.


While agriculture continues to employ a significant portion of the population, its low productivity is a concern. Moreover, the weakening of India's institutional framework — legal systems, press freedom, and other checks and balances — could shake the confidence of investors.


To avoid squandering its economic potential, India must persevere with its reform agenda and strengthen its institutions, ensuring that its moment of economic prosperity is not just a temporary blip but the beginning of a lasting legacy.


Adapted from WSJ, FT, NYT, Reuters, CNBC, The Economist

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