The
MPC (Monetary Policy Committee) of the RBI raised the policy repo rate by
50 basis points from 4.40% to 4.90%. Consequently, the standing deposit facility (SDF) rate stands adjusted to
4.65%, and the marginal standing facility (MSF) rate, and the Bank Rate to
5.15%.
The MPC also dropped the phrase “staying
accommodative” from its forward guidance and guided it to “remain focused
on withdrawal of accommodation to ensure that inflation remains within
the target going forward, while supporting growth”.
Consumer price inflation has been
running above the RBI’s upper threshold of 6% since the start of this year
averaging at 6.72% between January-April 2022. RBI’s own estimate of average
inflation in the fiscal year 2022-23 has been revised higher from 5.7% to 6.7%.
The RBI is now squarely focused on
bringing down inflation. The MPC statement noted - “Continuing shocks to
food inflation could sustain pressures on headline inflation. Persisting
inflationary pressures could set in motion second round effects on headline
CPI. Hence, there is a need for calibrated monetary policy action to keep
inflation expectations anchored and restrain the broadening of price
pressures.”
Taking into account the introduction
of the SDF in the April monetary policy at rate of 25 basis points below the
repo rate, the RBI has raised the effective overnight interest rate by 130
basis points over the last two months. The floor policy rate before the April
monetary policy was at 3.35% (the reverse repo rate). It has now moved to the
SDF rate of 4.65%.
This clearly shows a sense of urgency
within the RBI to withdraw the ultra-easy monetary policy.
Given the fact that the policy repo
rate is still significantly lower than the expected inflation rate, the RBI may
continue with the rate hikes in the remaining MPC meetings in 2022. However,
the pace of rate hikes (quantum of hike in each policy) may slow down after the
covid time the ultra-accommodative monetary policy is reversed.
Before the Covid shock, the Repo rate
was at 5.15%. With another 25-50 basis points hike in the August meeting, the
repo rate will get to the pre-covid level. Overall, we expect the repo rate to
peak around 6% by early 2023.
On liquidity, the RBI reiterated to
normalise the pandemic-related extraordinary liquidity surplus over a
multi-year time frame though it kept the CRR (Cash Reserve Ratio) rate
unchanged in this policy.
The bond market was already pricing
for a 40-50 basis points rate hike in this policy. So, the policy outcome was
broadly in line with the market expectation.
However, after the surprise repo rate
and CRR hike on May 4, 2022, the market had built in some premium for another
CRR hike and/or an outsized repo rate hike in this policy. To that extent,
there was a positive surprise for the bond market.
Bond yield came down 3-9 basis points after the policy announcement. The 5-year government yield came down from 7.36% to 7.28% during the day.
Much of the potential rate hikes are
already priced in the current bond valuations. The yield spread between the 3-year
bond (6.94%) over the 3 months treasury bill (4.98%) is around 196 basis points
vs its long term 20 year average of around 70 basis points.
Thus, the bond market may not be too
sensitive to RBI’s rate hikes going forward. However, high uncertainty over
global monetary policy, rising crude oil prices, and unfavourable demand-supply
dynamics will continue to put upward pressure on medium to long-term bond
yields.
Lending rates have already moved up
as most loans today are linked to benchmarks like Repo rate or MCLR. We should
expect further upward revision in lending rates. The interest rate on fixed deposits
will also move higher in the coming months.
From an investor's perspective, the
return potential of liquid and debt funds has improved significantly after the
sharp jump in bond yields over the last six months. The gap between the bank
savings rates and liquid fund returns will widen and remain attractive for your
surplus funds. Investors with a short holding period and low-risk appetite
should stick to categories like liquid funds of good credit quality portfolios.
Medium to Long term interest rates in
the bond markets are already at long-term averages as compared to fixed
deposits which remain low. Investors with more than 2-3 years holding period
can consider dynamic bond funds which have the flexibility to change the
portfolio positioning as per the evolving market conditions. However, such
investors should be ready to tolerate some intermittent volatility in the
portfolio value.
In
the Quantum Dynamic Bond Fund, we have been avoiding long-term bonds for some
time due to our cautious stance on the markets. After the steep sell-off in the
last two months, valuations have become attractive on medium to long-term
bonds. However, given the high uncertainty as mentioned above, we will continue
to be cautious in adding into long-duration bonds as a core portfolio position.
We
continue to like the 3-5 year segment of the bond market, the bulk of the QDBF
portfolio is in 3-4 year maturity government bonds.
We
would remain open and nimble to exploit any market mispricing by making a
measured tactical allocation to any part of the bond yield curve as and when
the opportunity arises.
We stand vigilant to react and change the portfolio positioning in case our view on the market changes.
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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