Note to fixed income investors – 06 Oct 2023

The Monetary Policy Committee of the RBI decided to keep the policy repo rate unchanged at 6.5%, a fourth pause decision in a row. The decision was unanimous. 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 5:1) the stance unchanged at “withdrawal of accommodation” to ensure that inflation progressively aligns with the target, while supporting growth.  

The governor sounded more hawkish today than the previous policy outcome. Two key aspects that signal hawkish tone are 1) reiteration of headline inflation target of 4% and not 2% to 6%. 2) Open Market Operation (OMO) sales to absorb excess liquidity from the banking system.

The G-sec yield curve saw some steepening lately, although major part of the curve continues to remain flat. OMO sales and resultant tight liquidity will keep shorter end of the curve elevated. The recent announcement by JP Morgan on India’s inclusion to its Global Diversified Emerging Market Index, ensuring a passive flow of ~$24 bn by March 2025 is a big sentiment booster. This move will keep yields at the longer end of the yield curve under control.

Despite recent surge in crude oil prices and US Treasury bond yields, the Indian government securities have witnessed a muted response to these developments. The yields are largely anchored by the anticipation of foreign inflows.

We believe, the cumulative impact of the 250-bps hike in policy rates over the last 12 months 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 a prolonged pause. The 10-year G-sec, in the short term, is expected to continue to trade in a range of 7.2% to 7.4% in the absence of any adverse event.

Strategy for fixed income investors

• With the recent spike in yields and with interest rates at the peak of the current cycle, yields offer a decent accrual and a possibility of participation in capital appreciation. Long-term yield may see some widening soon, and hence, medium & medium to long-term debt allocation can be considered, to benefit relatively more with moderation in yields.
• Corporate bond spreads are still lower than the LTA amid lack of supply in the bond market and may not offer attractive reward for risk. Spreads have just about started to appear attractive after adjusting for risk, although still low relative to history. Single A segment is witnessing some widening in credit spreads.

One should continue to consider debt as a part of the overall asset allocation mix as it helps to fundamentally diversify the portfolio. This can also be achieved by considering select corporate bonds and hybrid mutual funds (equity savings, multi-asset, and balanced advantage funds).

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