During its review meeting on Thursday, the Reserve Bank of India's Monetary Policy Committee (MPC) decided to keep interest rates unchanged for the sixth consecutive week. Additionally, it persisted in its "withdrawal of accommodation" posture. The MPC is resolutely working towards two objectives: (i) finishing up this cycle's 250 basis point (bps) rate hike; and (ii) bringing headline inflation in line with its 4 percent target.
Experts noted that since the RBI is keeping things as they are, this is the right moment for investors to choose long-duration bond funds.
According to Anshul Gupta, Co-founder and Chief Investment Officer of Wint Wealth, "After surging following the budget, bond yields climbed modestly following the MPC. It's a fantastic chance for investors to lock in high rates on long-duration fixed-income products, like bonds or fixed deposits, given that the market is still anticipating rate cuts a few quarters from now."
The governor of the RBI justified the "withdrawal of accommodation" attitude by citing the RBI's inflation target and policy transmission. The governor emphasized that the credit market has not yet fully absorbed the effects of previous monetary policy operations and that CPI inflation is still higher than the RBI's 4% target. The RBI appears to be more concerned about food inflation due to its volatility and lack of certainty in food pricing.
Since May 2022, the RBI has increased the repo rate by 250 basis points. This hasn't entirely translated into lending and deposit rates, though. In January, there was a 2 bps increase in vehicle lending rates and a 5 bps increase in the deposit rate, which had been stable for the previous three months. However, because of reduced systemic liquidity, which has raised rates over the past several months, money market rates have increased more quickly than the repo rate, according to a note from rating agency Crisil. Furthermore, as a result of the government increasing spending, the liquidity shortfall in the banking system decreased from its peak of Rs 3.46 lakh crore on January 24 to approximately Rs 1.40 lakh crore on February 4.
How does this affect the price of bonds?
Even if the Middle East conflict is still ongoing, crude prices have decreased, and over the past few months, global bond yields have sharply declined from their highs. The RBI is probably going to concentrate on macroeconomic stability and liquidity management till the conclusion of the fiscal year in March 2024. Due to the lack of liquidity, the short-term rates are also quite profitable. Government papers are offering rates of seven percent or more per year, which is far greater than what big banks are offering for savings accounts. Investors can transfer funds to these short-term papers that are needed for short-term objectives.
"We still think that rate decreases in India will occur beginning in the third quarter of 2024. We think now is the appropriate moment for investors to start raising their allocation to fixed income, especially at the longer end of the curve, as bond yields often react ahead of the start of a rate-cutting cycle.Given their present superior risk-reward profile, funds with a duration of 6-7 years and a predominance of sovereign holdings may be of interest to investors with medium- to long-term investment horizons. Money Market Funds are a good option for investors with a six- to twelve-month investment horizon because of their strong yields in the one-year region of the curve. By Q3 of CY2024, we anticipate that the benchmark 10-year bond rate will have steadily fallen to 6.50%," said Puneet Pal, Head - Fixed Income, PGIM India Mutual Fund.
Since the December 2023 MPC meeting, the yield on sovereign bonds has decreased. The benchmark 10-year yield has dropped by 20 basis points to 7.07%, while the 30-year IGB yield has eased by 30 basis points to 7.13% following the policy decision. "The IGB yield curve is "bullishly flattening." We think value is gradually emerging in the 10-year portion of the yield curve, with spreads between the 10- and 30-year IGB at all-time lows. After the rate-cut cycle begins, we anticipate that the benchmark 10-year IGB will progressively trend towards two levels: 6.90% by mid-2024 and 6.75% after that," said Dhawal Dalal, President & CIO - Fixed Income, Edelweiss Asset Management Limited.
Dalal believes that investors should think about lengthening the duration in their fixed-income portfolios by purchasing sovereign bonds with 10-year maturities in the midst of record low long-end spreads.
Because of the tight liquidity situation, we anticipate that short-term money market rates will continue to rise. Liquid funds that depend on interest accruals on short-term debt instruments should benefit from this. The outlook for the bond market is still favorable due to the trend of declining inflation, the potential for rate reductions, the inclusion of global bond indices, and the favorable demand-supply mix. To perhaps profit from the declining bond yields, investors with a short-term perspective of two to three years may want to look into dynamic bond funds. Liquid funds are best for conservative investors with shorter holding periods, according to Pankaj Pathak, Fund Manager, Fixed Income, Quantum AMC.
Debt mutual funds that invest over a range of durations are called dynamic bond funds. These schemes adjust the portfolio's securities' tenor in accordance with anticipated interest rate changes. If a decline in interest rates is anticipated, the tenure of these funds is extended, and vice versa. An open-ended debt mutual fund that invests in debt instruments having a maturity of less than ninety-one days is known as a liquid fund.Investments in debt securities with excellent credit quality are made by the fund portfolio. For a maximum of ninety-one days, they invest in money market instruments such as commercial paper (CP), treasury bills (T-bills), and certificates of deposit (CD).
