Note to fixed income investors – 08 Dec 2023

The Monetary Policy Committee of the RBI decided to keep the policy repo rate unchanged at 6.5%, a fifth 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.  

Some of the key mentions in the policy statement

1. Reiteration of monetary policy to be actively disinflationary with headline inflation target of 4%
2. Need for Open Market Operation (OMO) sales (announced in October meeting) not arisen so far as system liquidity tightened significantly compared to what was envisaged in the October policy statement
3. Globally, risk of policy overtightening and at the same time risk of reacting to a few months of good data or the fact that CPI inflation has come within the target range

In near-term, any major negative shock from inflation print (particularly food) due to abnormal monsoon, and unexpected further oil output cuts by OPEC, could dampen the bond market sentiment.

The benchmark 10-year G-sec yield touched 7.39% post the October policy, and since then, it has moved down to 7.23%. This can be largely attributed to the return of FPI flows in the Indian bond market and moderating crude oil prices.

With Indian G-sec yields being range bound, a fall in US Treasury increases the real rate attractiveness for Indian G-secs, which would support FPI inflows.

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 no sooner than Q2 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 interest rates around 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 (in case of adverse inflation shock). 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 started to widen 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 have started to 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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