Note to fixed income investors - August 08, 2024

As widely expected by the market, the Monetary Policy Committee (MPC) of the RBI decided to keep the policy repo rate unchanged at 6.5%, ninth 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 unchanged at 6.75%. The MPC also kept (with a vote of 4:2) 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. The MPC stays resolute in its commitment to aligning inflation to the 4% target on a durable basis
2. The MPC reiterates the need to continue with the disinflationary stance, until a durable alignment of the headline CPI inflation with the target is achieved. Hence the MPC also considers it appropriate to continue with the disinflationary stance of withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth

Globally, markets are going through a bout of heightened volatility driven by central bankers’ monetary policy action/commentary which led to narrowing of interest rate gap between US and Japan. As a result, yen appreciated against the US Dollar, leading to unwinding of carry trade which were linked to weak yen and ultra dovish monetary policy. Risk averse sentiment kicked in as investors rushed to safe haven asset such as treasuries. US 10-year treasury yield fell to 3.67% amid massive buying. India’s benchmark G-sec yield fell to 6.83%, tracking fall in US treasury along with this, FPI flows in the Indian bond market, expectation of policy rate cut and government’s adherence to fiscal prudence is supporting positive sentiment.

From the macro standpoint, the current goldilocks situation with GDP growth projected at ~7.2% for FY25 and inflation projected at 4.5% (but above the RBI target of 4%), might further delay any rate cut action by the RBI. However, concern of US economy slipping into a recession may fast track policy action by US Fed with Fed chair signaling a rate cut possibility in September. Timing and magnitude of rate cut by US Fed could potentially have a bearing on RBI’s action to maintain real rate attractiveness, supported by preferable local demand-supply dynamics.

Current term spread between 3-month T-bill and 10-year G-sec is around (~24 bps) vs long-term average term spread of ~1.4%. This is expected to normalize with improving banking system liquidity. With today’s announcement of no change in policy rate and stance by RBI, markets are now not expecting rate cut before Q4 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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