Note to fixed income investors – 09 Apr 2025
As expected by the market, the MPC unanimously decided to reduce the policy rate by 25 bps to 6% with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted at 5.75% and the marginal standing facility (MSF) rate and the Bank Rate at 6.25%. The MPC also decided to change the stance from neutral to accommodative. In the current global macro environment with heightened uncertainty around growth and inflation, the RBI’s MPC decides to support growth as inflation is expected to remain within the tolerance band and much closer to the 4% target.
The stance change is suggestive of more policy rate easing in the rest of calendar year. Also, with headline inflation expected at 4% for the current financial year and near-term growth headwinds, warrants for further policy easing to support growth.
On the liquidity front, lately, RBI undertook various steps such as CRR cut, buybacks, VRR, OMO purchase and currency swap to provide adequate banking system liquidity which is now in surplus mode. This should help policy rate transmission to happen in an efficient manner.
Bond market had largely priced in today’s policy rate cut as the 10-year benchmark G-sec yield saw meaningful drop since Feb announcement and is now trading at 6.48% vs 6.75% in Feb. The term spread between 3-month T-bill and 10-year G-sec at ~20 bps continues to remain lower than the long-term average (LTA) term spread of ~120 bps. This is expected to normalize further with improving banking system liquidity and policy rate transmission. 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 fall in G-sec yields over the last twelve months, our overweight call on duration has played out reasonably well and we continue to maintain our stance in favor of medium to long-term duration. Though the fall in yields have reduced the expected quantum of incremental capital appreciation, there is still a possibility of participation in capital appreciation over the next few quarters with expectation of further policy rate easing. Long-term yield could remain sensitive to the evolving growth-inflation dynamics.
- Corporate bond spreads remain muted with AAA spreads 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.
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