An unexpected slowdown in US GDP growth delivered a mini-shocker for the markets this week. The world’s largest economy’s first-quarter growth fell behind estimates, rising at an annualised rate of 1.6 percent—lower than the consensus estimate of 2.5 percent and sharply behind the 3.4 percent increase seen in the previous quarter. Textbook theory dictates that such a sharp slowdown in economic activity warrants immediate interest rate cuts, but analysts are not expecting any monetary easing, anticipating a hotter-than-expected inflation number. It is this slow-growth-high-inflation combination—which economists call stagflation—that’s a central banker’s nightmare, worse than even a recession. But some believe that concerns about stagflation are premature, as both the high inflation and slow growth appear to be an anomaly rather than a trend. In other words, even if interim data indicates otherwise, the overall trend is expected to remain positive.
This anticipation has been keeping markets cheerful despite the blips in data. A high inflation scenario is an indication of higher-for-longer rates narrative, but notwithstanding sticky prices, markets are pricing in rate cuts. If at the start of 2024 they expected at least three rate cuts, with the first in June, that prospect is now deferred; the number of expected cuts are down to at least one. Besides delaying monetary easing, high inflation is also causing a spike in US bond yields. On Thursday, the 10-year benchmark yield touched more than a five-month high at 4.72 percent after data showed a particular measure of inflation rose more than expected in the first quarter. Global crude oil prices, one of the key factors that could keep prices elevated, is also on the rise with some predicting it to touch $100 per barrel amid escalating tensions in the Middle East.
India continues to be the fastest growing emerging economy—economic activity is showing signs of broad-based growth, with the pace of private consumption and investments getting better. While rising bond yields could prompt foreign investors to reallocate their funds from riskier assets, potentially triggering capital outflows from domestic markets, equities are expected to adjust slightly lower but will remain supported by strong economic conditions and company earnings. The fallout of potential capital outflows can be mitigated if domestic growth drivers remain robust and inflation is under control.