The yield curve and what to bear in mind
Now, the market has been divided into which part of the curve to remain focussed on, as the yield curve has flattened. Whether you take 1y Tbill or 30yGSEC, the rates are around 7%, give or take. The RBI repo rate as everyone knows, is 6.5% - the next move, we and the market believe, will be down, but the timing is not clear basis current inflationary dynamics
If you ask where the are, it means different things to different people. Generally, the topic goes to where sets interest rates (“kya lagta hi?”). and inflationary expectations will be discussed. More involved participants will look at where the 10Y Indian Government Bonds are trading. But as you come closer to the bond desk, the talk will move to the yield curve. So, the focus will be on which tenure security to take – referred to the point in the yield curve. This is because the shape of the constantly changes and provides opportunities to . Various strategies are adopted – barbell, bullet, on-the-run vs off-the run to try maximising returns/minimising pain.Now, the market has been divided into which part of the curve to remain focussed on, as the yield curve has flattened. Whether you take 1y Tbill or 30yGSEC, the rates are around 7%, give or take. The RBI repo rate as everyone knows, is 6.5% - the next move, we and the market believe, will be down, but the timing is not clear basis current inflationary dynamics. Some therefore feel it is better to be in the shorter end (say 5Y) of the curve, as eventual rate cuts will result in curve to become steeper ie. 5Y yields will decline more than say a 15 year, but yet offer protection if the rates were to rise.
Compounding this discussion are developments in the dominant (size and attention seeking!) and the new post-pandemic world that we are in. Historical correlations (India-US interest rate differential) have now to be relooked at as inflation remains persistent in the US, compared to India. And look at the change in the - in the beginning of the year, the market was expecting 7 rate cuts in the US due to falling inflation, and now is expecting 2 due to fears of falling growth! The dual mandate of the US Fed (like with RBI in India), of balancing growth and inflation has driven this.
Dear Prudence
This comes to the most important part of our positioning, which is in long-term bond namely demand-supply. This seems mundane but is important. The bigger issue in the US is that of fiscal deficits. The USD as a reserve currency allowed to US to run large fiscal deficits. This now appears to be a drug that the US is on, and indeed, it is one of the reasons that inflation is still persistent in the US (immigration led growth is a Johnny-come-lately theme too). Electoral dynamics is also keeping markets treading water.
In this environment, if we were in the US, we would probably be happier in the 5-10Y as Federal Reserve cuts will cause yields to fall there, and supply will keep the longer yields elevated. In that context, India looks good. Firstly, the GoI “thinks” fiscal deficit and aims to keep it in control. This year demand for bonds got a fillip from foreign flows and index inclusion, and supply could potentially benefit from the extra dividend from RBI (the denouement will be in the Union Budget to be presented end July). Regardless, steady demand from longer term investors – pension funds and life insurance companies have reached meaningful and predictable levels and absorbing supply.
Of course, it is world fraught with geo- and local political risks and if US yields move up sharply, it is likely to have an impact on Indian yields, if not directly, then through FX markets. While we remain watchful of these, to us, the factors that caused the yield curve to flatten to current levels still exist. We feel there is value in keeping positions in the longer Indian Government Bonds, even as we are nimble to developments.
(The author Vivek Ramakrishnan is VP - Investments, DSP Mutual Fund. Views are own)
Source: Stocks-Markets-Economic Times
