In the bond market, the sentiment pendulum has
swung from one extreme to another over the last two months. Relentless rise in
the US treasury yields and surprise jump in domestic inflation have rattled the
investor sentiment in the Indian bond markets pushing bond yields higher and
prices lower.
The 10-year Indian government bond (Gsec) yield
which had fallen to lows of 6.95% in May, has jumped to the peak of 7.26%,
before pulling back to the current levels of 7.22% on August 21, 2023.
Chart – I: Indian yields tracking
UST, Crude and Inflation on way up
Source – Refinitiv, Quantum
Research, Data as of Aug 21, 2023
Past performance may or may not sustained in the future.
The underlying forces driving the bond yields
over the last two months, continue to remain uncomforting -
·
The
US 10-year treasury yield, after rising sharply from levels of 3.5% during May
2023, is now holding above 4.2%.
·
The
Crude oil price has risen more than 16% over the last two months and is still
holding above the USD 85/barrel.
·
The
headline consumer price inflation in India jumped to 15 months high of 7.44% in
July 2023 and expected to remain elevated for the next few months.
Chart – II: US treasury yields moving higher on resilient growth data and heavy supply
Source – Refinitiv, Quantum
Research, Data as of Aug 21, 2023
Past performance may or may not sustained in the future.
Tipping Point
The recent significant jump in the US treasury
yields seems justified given – (1) the resilience shown by the US
economy and the labour markets, and (2) sharp jump in treasury issuances.
However, for long term yields to
go even higher and sustain there would require incremental strengthening of
economic activity and serious worsening of future inflation trajectory. These
conditions seem unlikely to hold given the synchronised global monetary policy
tightening will continue to put restraint on demand.
We also note that interest rates
in most of the developed world are at a level not seen in long time. The
financial system in many places including the US is not accustomed to this high
interest rates. This makes the financial system vulnerable to shock if the
current level of US treasury rates sustains for long or move higher.
We have seen some short episodes
of financial system vulnerabilities during September 2022 in the UK pension
funds and during Mar 2023 in the US regional bank crisis. Once again, the
financial condition in the US is tightening quickly. This is at a time when the
corporate default rate is also showing an uptick.
In our opinion, the financial
system risks should outweigh the supply risk in the US treasuries. We see
higher probability of long-term US treasury yields coming down than moving
higher.
Inflation havoc
In India, the inflation momentum was falling
since start of the year until May, when vegetable prices started to rise
sharply. The CPI inflation spiked to 15 months high in July to 7.44% as against
average inflation of 4.65% between April- June 2023.
However, the pickup in inflation was not
broad-based. It was almost entirely contributed by the sharp surge in food
prices especially that of cereals (11.02% yoy), Milk (8.02%), vegetables
(33.96%), pulses (12.08%) and spices (20.09%).
These items constitute 27.2% of the CPI basket
but contributed more than 65% to the total headline inflation in July. Rise in
tomato prices alone contributed 114 basis points to the headline CPI.
CPI inflation excluding vegetable remained same
as the previous month at 5.4% in July. The Core CPI which excludes the volatile
food and fuel prices, dropped to 5.0%.
Chart – III: CPI Inflation spiked to 15 months high led by surge in food price
Source – Mospi, Quantum Research, Data as of Aug 14,
2023
Past performance may or may not sustained in the futu
Going by the history, impact of vegetable
prices should be transitory. As the fresh produce come in September-October,
vegetable prices should fall. We are already noticing some cooling off in the
prices of tomatoes.
Although kharif sowing started late due to
delayed monsoon, it picked up quickly during July and August as monsoon spread
widened. As on August 18, 2023, overall area sown under Kharif crops stood at
102.3 million hectares which is 0.1% higher than previous year.
Chart – IV: Kharif sowing started
late but recovering fast
|
Sr.No. |
Crops |
Normal area |
Area Sown (Million Hectare) |
% YOY |
|
|
2023 |
2022 |
||||
|
1 |
Rice |
39.9 |
36.1 |
34.6 |
4.34% |
|
2 |
Total
Pulses |
14.0 |
11.5 |
12.7 |
-9.16% |
|
3 |
Total
Coarse Cereals |
18.2 |
17.6 |
17.4 |
1.61% |
|
4 |
Total
Oilseeds |
18.6 |
18.6 |
18.9 |
-1.68% |
|
5 |
Sugarcane |
4.9 |
5.6 |
5.5 |
1.34% |
|
6 |
Total
Jute and Mesta |
0.7 |
0.7 |
0.7 |
-5.61% |
|
7 |
Cotton |
12.9 |
12.2 |
12.4 |
-1.89% |
|
|
Grand
Total |
109.2 |
102.3 |
102.1 |
0.10% |
Source – Agricoop, Data as of Aug 21, 2023
Nevertheless, there could be some more upside
pressure on cereals due to rising international prices and on pulses due to
lower sowing during the current Kharif season.
There is also a risk that lower rainfall in
some areas could affect the quality of kharif production and the Rabi sowing
later in the year which mostly depends on the accumulated water during the
southwest monsoon.
Chart – V: U
neven Monsoon distribution
poses risk to Rabi Crops
|
Region |
Actual |
Normal |
% Departure from Long Period Average |
|
EAST AND NORTHEAST INDIA |
776.3 |
971.0 |
-20% |
|
NORTHWEST INDIA |
452.2 |
426.7 |
6% |
|
CENTRAL INDIA |
688.7 |
703 |
-2% |
|
SOUTH PENNINSULA INDIA |
431.1 |
494.6 |
-13% |
|
COUNTRY AS WHOLE |
579.3 |
619.8 |
-7% |
Source – IMD, Agricoop, Data as of Aug 21, 2023
The government has a decent history of keeping
food prices under check by proactively managing the demand supply in the
market. As food prices moved up, they have started to intervene actively
through open market sale of many impacted food items like rice, pulses,
tomatoes, and onions. We expect these supply side interventions to bring down
the food inflation over coming months.
For the non-food inflation, we continue to
expect the disinflationary momentum to continue (Past, Present and Future of
Inflation) as the sluggish recovery of
consumption demand and expanded corporate margins would keep prices stable at
the consumers’ level. Slowing Chinese economy should also be helpful in keeping
commodity prices under check.
To summarize, the headline CPI might remain
elevated for the next 2-3 months due to vegetable prices. It could also push
the average CPI for the FY24 to near or above 5.5%. However, much of it is due
to a transitory price shock in vegetable price in the last two months and have
no impact on the underlying inflation momentum.
We expect the headline CPI inflation to
converge towards the Core CPI Inflation of 5% by the early 2024.
Bond Outlook
The near-term
uncertainty about the global interest rates and domestic inflation might keep
bond yields elevated in near term.
However, looking through all the near-term noises, the
medium-term outlook for bonds looks favourable supported by peaked policy rates, comfortable
liquidity condition and strong external position.
After recent rise in bond
yields, valuations have also improved. We see limited upside in yields from
current levels as the overall macro backdrop is favourable.
In line with this view, we would use every rise in yield to extend the portfolio duration by accumulating long term bonds in a staggered manner.
What should Investors do?
With most of
the government bond yield curve above 7.2%, there is decent accrual available
at current levels. Even in the real
term (adjusted for inflation), government bonds are offering meaningful
positive real yield. With
expected CPI inflation of 5.2% (RBI’s Q1FY25 inflation estimate) and a 1-year
Gsec yield at 7%, the real yield is around 180 basis points.
Chart – VI: Real yields are positive and reasonably high
Source – Refinitiv, Quantum Research, Data as of Aug
21, 2023
Investors with 2-3 years holding period can consider Dynamic
bond funds which have
flexibility to change the portfolio positioning as per the evolving market
conditions.
Investors with shorter investment horizons
and low-risk appetites should stick with liquid funds.
Portfolio Positioning
|
Scheme Name |
Strategy |
|
Quantum Liquid Fund |
The scheme invests in debt securities of up to 91 days of maturity
issued by the government and selected public sector companies. |
|
Quantum Dynamic Bond
Fund |
The scheme to invest in debt securities issued by the government and
selected public sector companies. The scheme follows
an active duration management strategy and increases/decreases the portfolio
duration (sensitivity to interest rates changes) in accordance with the
Interest Rate Outlook. Given our favourable
medium-term view and reasonable valuation in long term bonds, we have
extended the portfolio maturity of the scheme. However, we are ready to act
quickly to market developments and upcoming data points. |
|
Portfolio Information |
|
|
Description (if any) |
|
|
Annualised Portfolio YTM*: |
6.79% |
|
Macaulay Duration |
33 Days |
|
Residual Maturity |
33 Days |
|
As on (Date) |
30-06-2 |
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read all scheme related documents
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