The Repo rate hike of 35 basis points was broadly in line with the market expectation. However, a continuation of the stance as “withdrawal of accommodation” indicates that the rate hiking cycle in India is by no means over. We would expect at least another 25 basis points of a rate hike in February next year before we get any closer to the terminal rate.
The bond market will be disappointed with the hawkish commentary from the RBI. We might see some selling in the bond market in the coming days. However, given the high level of absolute yields at medium to long-term bonds, 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 the fact that a sizable rate hike has 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 year investment horizon and some appetite for intermittent volatility, can continue to add to dynamic bond funds in a staggered manner.
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. Investors with shorter holding periods and low-risk appetite should stick to Liquid funds.
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