Fixed Income Monthly Commentary – July
2022
June 2022 was a month of two halves.
The first half of the month was dominated by an ‘inflation’ narrative. Bond
yields in India and globally moved up - pricing for higher inflation for a longer
period and more aggressive central bank action.
But we reached the peak of inflation
scare by the middle of the month. In the second half, the pendulum swung towards
the ‘recession’ narrative. Markets started pricing for a contraction in the
economic activity across many advanced economies.
The US 10 treasury started acting
like a haven asset as investors rushed to seek protection. Bond yields dropped;
prices jumped.
The US 10-year treasury yield peaked
at 3.47% on June 14, 2022, a day before the US Federal Reserve hiked the Fed Funds rate by 75
basis points. It fell to 3.01% by June 30, 2022. At the time
of writing this report on July 6, 2022, the 10-year US treasury note is trading
at a yield of 2.81%.
Indian bond yields followed a similar
path as the US treasury yields, though at a slower pace. The 10-year Indian government bond yield peaked at
7.60% on June 13, 2022, and fell back to 7.45% by the month-end. Currently, on
July 6, 2022, the 10-year Indian government bond is trading at a yield of 7.30%.
Commodity prices also came off from
its April-May 2022 peak in fear of economic contraction and demand destruction.
As of July 5, 2022, most of the metal commodities are down by 10%-20% since the
end of May 2022. Many of the Agricultural commodities have also come off by
5%-20% during this period.
From India’s perspective, the most
notable is the decline in crude oil, palm oil, and wheat prices which fell by
14%, 37%, and 23% respectively in one month period ending July 5, 2022. These were major contributors to domestic
inflation on the way up. So, this drop in prices should ease some of the
inflationary concerns.
From the bond market’s perspective,
the tussle between the two narratives of Inflation and Recession in the US will
continue to shape market expectations. If indeed the economic activity decline
at an accelerated pace and the US economy gets into serious contraction - the
US Fed may slow down the pace of rate hikes, global commodity prices will
soften and bond yields will come down further.
However, if this economic slowdown
is not that serious, central banks will continue to focus on the inflation
problem and rate hikes may continue.
Although we expect the global
economy to slow down due to high inflation and synchronized global monetary
policy tightening, it may not fall into recession as quickly as expected.
Employment numbers in the US are
fairly strong, incomes are still growing at a healthy pace and there is a
saving buffer available to spend. Corporate
sector balance sheets carry lesser debt and are stronger than before.
We may possibly see a slowdown in
the demand for goods and consequently in the manufacturing activity; while
demand for services like travel, recreation, etc. picks up due to the removal
of pandemic-related restrictions.
We do not see any material change in
the FED’s policy direction and its commentary in the upcoming monetary policy
on July 27, 2022. It will likely hike the Fed Funds rate by another 50 or 75 basis
points as was guided earlier.
Thus, we see the recent move down in
the US treasury yields as a temporary retracement and expect it to rebound over
the coming months.
For the Indian bond market, local inflation and
demand-supply dynamics will likely have a greater influence. A drop in
commodity prices should help in easing some of the inflationary concerns. But
it may not be enough to have any material impact on the RBI’s policy direction
and its pace, as yet.
We expect another 35-50 basis points of a rate
hike in the August meeting of the RBI’s monetary policy committee. 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 pandemic time ultra-accommodative monetary policy is reversed.
Overall, we expect the repo rate to peak around 6% by early 2023.
Since bond yields
have come down sharply over the past two weeks, there is a possibility of a reversal
in the near term.
From a medium-term
perspective, mostof the potential rate hikes are already priced in the current
bond valuations. Thus, the bond market may not be too sensitive to RBI’s rate
hikes going forward.
However, the adverse
demand-supply gap will continue to put upward pressure on the longer maturity
bonds. We continue to like the 3-5 years segment of the bond market, which in
our opinion, offers the critical balance between the accrual (interest income)
and duration (price changes). At this stage, our priority is to have higher
accrual with a lower duration.
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 12
months. The gap between the bank savings rates and liquid fund returns will
widen further 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.
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.
No comments:
Post a Comment