Fixed Income Monthly
Commentary – December 2022
The bond market has a
positive run in November with bond yields coming down by 10-25 basis points
(bond prices increased) across different maturities of government bonds. The benchmark
10-year Indian government bond yield fell by 17 basis points to close at 7.28%
on November 30, 2022.
The two main drivers of the
bond rally in the last month were – (1) an over 10% decline in crude oil price
amid slowing global growth and lockdown in China, and (2) a steep drop in US
treasury yields in expectation of the US Federal Reserve slowing down the pace
of rate hikes.
Domestically, the Reserve
Bank of India also slowed down the pace of rate hikes by raising the repo rate
by 35 basis points in the December MPC meeting from 5.9% to 6.25%. This was
slower than three back-to-back 50 basis points increases and a 40 basis point
increase in four preceding MPC meetings.
The RBI maintained
its policy stance as “withdrawal of accommodation” with a focus on bringing
down the core inflation (ex-food and fuel inflation) which has been steaky
above the RBI’s 6% upper threshold. This indicates that the rate hiking cycle in India is not over.
We would expect at least another 25 basis
points of a rate hike in February next year. The RBI might pause the hiking
cycle thereafter subject to inflation trajectory and global monetary policy
developments.
With RBI monetary policy out of way, the bond
market will switch its focus to the US fed meeting due on December 14, 2022,
and to fiscal calculations ahead of next year’s budget.
The US Fed is widely expected to hike interest
rates by a reduced quantum of 50 basis points (vs 75 basis points increase in 3
three preceding meetings) in the upcoming FOMC meeting. However, given the
recent robust data on the jobs market with the unemployment rate near a multiyear
low at 3.7% and over 5% year-on-year increase in average hourly wages, we
should expect the Fed to remain hawkish in its statement.
Going ahead, Indian
bond yields will closely track these developments and the movement in US
treasury yields and crude oil prices.
After a steep fall in yields
over the last one month, there is a possibility of a rebound in yields from
current levels. However, given the high level of absolute
yields across the yield curve, we expect the upside to remain capped. We expect
the 10-year government bond yield to continue to trade between 7.2% to 7.5%.
Given much of the rate hikes have already been
delivered and the starting yields on short to medium-duration bonds are between
7.0%-7.5%, bond funds are likely to do better over the coming 2-3 years.
Investors with a 2-3 years investment horizon and some appetite for
intermittent volatility, can continue to add to dynamic bond funds in a staggered
manner.
Dynamic bond funds have the flexibility
to change the portfolio positioning as per the evolving market conditions. This
makes dynamic bond funds better suited for long-term investors in this volatile
macro environment.
Investors with shorter
investment horizons and low-risk appetite should stick with liquid funds. Rate hikes and continued reduction in durable liquidity surplus are positive
for short-term debt fund categories like the liquid fund. We would expect
further improvement in the return potential of these categories as interest
accrual on short-term debt instruments has risen meaningfully.
Since the interest rate on
bank saving accounts are not likely to increase quickly while the returns from the
liquid fund are already seeing an increase, investing in liquid funds looks
more attractive for your surplus funds.
Investors with a short-term
investment horizon and with little desire to take risks should invest in liquid
funds which own government securities and do not invest in private sector
companies which carry lower liquidity and higher risk of capital loss in case
of default.
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and reasonable as on date. Readers of this article should rely on
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