Fixed Income Investment Strategies and Market Outlook | RBI Policy Repo Rate Unchanged
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Note to fixed income investors - Apr 5, 2024

    As expected by the market, the Monetary Policy Committee (MPC) of the RBI decided to keep the policy repo rate unchanged at 6.5%, a seventh pause decision in a row. Consequently, the standing deposit facility (SDF) rate stands unchanged at 6.25% and the marginal standing facility (MSF) rate and the Bank Rate also remains unchanged at 6.75%. The MPC also kept (with a vote of 5:1) the stance unchanged at “withdrawal of accommodation” to ensure that inflation progressively aligns with the target, while supporting growth.

     

    Some of the key mentions in the policy statement:

    1. Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process, posing challenges for the final descent of inflation to the target.
    2. Path of disinflation needs to be sustained till inflation reaches the 4% target on a durable basis.

    The benchmark G-sec yield has moderated in the last six months from ~7.4% to 7.10% as of Apr 5, 2024, largely attributed to the return of FPI flows in the Indian bond market, expectation of policy rate cut and government’s adherence to fiscal prudence. We believe, further moderation in yields would largely be dependent on quantum and timing of policy rate cuts and easing demand supply dynamics as growth forecast remains strong.

    On the liquidity front, RBI has been managing liquidity by taking adequate measures such as variable rate repo and reverse repo auctions (VRR and VRRR) at regular intervals to manage banking system liquidity and money market rates. Weighted average call rate fluctuated in the range of 6.85% to 6.35% basis evolving liquidity situation.

    Current term spread between 3-month T-bill and 10-year G-sec is at historical low levels (~6 bps) vs long-term average term spread of ~1.4%. This is expected to normalize with improving banking system liquidity. We believe, the cumulative impact of the 250-bps hike in policy rates since May 2022 is yet to be fully reflected in the economy, which typically happens with a lag. With today’s announcement of no change in policy rate and stance by RBI, markets are now expecting rate cut not before Q3 of FY2025. The 10-year G-sec, in the short term, is expected to continue to trade in a range bound manner in the absence of any adverse event.

     

    Strategy for fixed income investors:

    • With expectation of policy rates coming down, G-sec yields offer a decent accrual and a possibility of participation in capital appreciation over twelve to eighteen months. Long-term yield could remain sensitive to the evolving growth-inflation dynamics. Despite this, the current medium & medium to long-term yield levels appear relatively attractive and gradual increase in debt allocation could be considered, to benefit relatively more with anticipated moderation in yields.
    • Corporate bond spreads have widened lately, although AAA spreads are still lower than the LTA amid lack of supply in the bond market. In select instances, spreads for AA and A appear attractive after adjusting for risk. Investor with an appetite for credit risk could start evaluating select high yield strategies.

    We continue to maintain neutral stance on overall debt allocation across risk profiles. Debt as a part of the overall asset allocation mix helps to fundamentally diversify the portfolio. This can be achieved by considering select debt and hybrid solutions.

     

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