Much of this rally in the bond market can be
attributed to the steep fall in crude oil price from its 3-year peak. A group
of large oil consumers, including the US, China,
India, South Korea, Japan and Britain, decided to use their strategic oil
reserves instead of importing crude oil to cool off the prices. Following the
announcement, the Brent crude oil price fell to ~USD 80/barrel vs USD
84.4/barrel at start of the month.
It fell
further by the month-end as a new highly mutated variant of Covid-19 (Omicron)
started spreading in various parts of the world. Although health agencies are
still studying the new virus to determine its characteristics, fear of renewed
travel restrictions and potential dampening of economic momentum due to the
virus led to over 11% drop in Brent oil price to ~USD 71/barrel by the month-end.
Fall in crude oil prices and tax cuts on petrol
and diesel are incrementally positive and should lower the fuel and
transportation inflation in the coming future. However, the overall inflation dynamics have worsened over the last two months in India and
globally.
In the US,
CPI inflation surged to 6.2% in October 2021. It is the highest print in over
30 years. In the Eurozone, CPI inflation surged to 13 years high at 4.1% in
October 2021. Other Advanced and Emerging economies too witnessed an abnormal
surge in inflation in the past few months.
A part of
the spike in inflation is due to the base effect and one-off price adjustments whichthat
should fade away over time. However, the ‘transitory’ narrative on inflation has
come under threat as the supply chain disruptions are likely to persist for a longer
period than earlier anticipated while unprecedented fiscal stimulus and
ultra-easy liquidity conditions are fuelling demand.
Under the US Federal Reserve’s new
framework which is based on average CPI inflation than inflation expectations,
it may become more tolerant to inflation and respond gradually. However, given
the fact that inflation is sustaining above the Fed’s target for some time and
it is turning out to be less transitory than presumed, expectations are
building up for an accelerated QE tapering and early rate hikes by the FED.
In the domestic economy, a sharp
unseasonal jump in vegetable prices and telecom tariff hike by over 20% will
more than offset the impact of tax cut on petrol and diesel. Corporates are
also facing increased cost pressures and raising prices across all kinds of
goods.
The headline CPI inflation stood at
4.48% in October 2021. Following the recent price actions and the underlying
trend across various goods and services, CPI is expected to jump past the RBI’s
6% upper threshold by December this year and sustain above the 6% mark during
most part of 2022.
Considering the natural rate of
inflation, the domestic inflation picture is still not that frightening as in
the developed world. However, it is sustaining well above the RBI’s 4% target
and near its upper threshold of 6% for a long enough time to warrant a change
in the policy direction. We expect some
of the MPC members to become incrementally hawkish and vote for early stance
change and rate hikes.
In the upcoming monetary policy review
on 6-8 December 2021, the RBI may kick start the rate hiking cycle by raising
the reverse repo rate by 20basis points. It should be followed by another
reverse repo rate hike in February next year and repo rate hikes in the latter
part of the year.
The direction of the
monetary policy is more or less discounted in the market expectation and the
current steep yield curve. Incremental change in the market expectations will
be driven by the timing of stance change, the pace of rate hikes and the length
of the rate hiking cycle or the terminal repo rate.
Although the macro backdrop is
unfavourable, valuations at 2-5 years part of the G-sec yield curve looks
comfortable. In our opinion, this segment is already pricing much of the liquidity
normalisation and a start of the rate hiking cycle by end of this year. Given
the steep bond yield curve, 2-5 years bonds also offer the best roll down
potential and thus a
reasonable margin of safety in the rising rate environment. Bulk of our holding
in the Quantum Dynamic Bond Fund is in the 2-5 years maturity segment.
Monetary policy is in
a transition phase in India and across the developed world. If history is any
guide, these transitions from easing to tightening monetary policy tend to
become chaotic with a lot of sentimental market movements on both sides. Thus,
we should be prepared for increased volatility in the bond market near and
after the policy announcements.
With this view, we have created
some cash in the Quantum Dynamic Bond Fund portfolio to lower the impact of any
adverse market movements around the policy.
We are closely monitoring the
developments around the new Covid-19 variant and its impact on the monetary and
fiscal policies. We stand vigilant to react and change the portfolio
positioning in case our view on the market changes.
From investors’ perspective, we
believe a combination of liquid to money market funds to benefit from the
increase in interest rates in the coming months; along with an allocation to
short term debt funds and/or dynamic bond funds with low credit risks should
remain as the core fixed income allocation.
We belive
bond fund investors should have longer holding period to ride through any
intermittent turbulence in the market.
Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video
are for general information and reading purpose only and do not constitute any
guidelines and recommendations on any course of action to be followed by the
reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering /
communicating any indicative yield on investments made in the scheme(s). The
views are not meant to serve as a professional guide / investment advice /
intended to be an offer or solicitation for the purchase or sale of any financial
product or instrument or mutual fund units for the reader. The article has been
prepared on the basis of publicly available information, internally developed
data and other sources believed to be reliable. Whilst no action has been
solicited based upon the information provided herein, due care has been taken
to ensure that the facts are accurate and views given are fair and reasonable
as on date. Readers of this article should rely on information/data arising out
of their own investigations and advised to seek independent professional advice
and arrive at an informed decision before making any investments.
Risk Factors: Mutual Fund investments are
subject to market risks, read all scheme related documents carefully.
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