RBI status quo: What it means for bond market and what should investors do

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) held rates steady for the sixth straight time at its review meeting on Thursday.  It also continued its stance of ‘withdrawal of accommodation’. The MPC is steadfastly pursuing two goals; (i) complete transmission of its 250 basis points (bps) rate hike in this cycle; and (ii) aligning headline inflation to its target of 4 per cent.

With the RBI maintaining status quo, experts said time is ripe for investors to opt for long-duration bond funds.

"Bond yields increased slightly post the MPC after rallying post the budget. Considering that the market is still expecting rate cuts a couple of quarters down the line, it’s a good opportunity for investors to lock in high rates in long-duration fixed-income products - be it bonds or fixed deposits," said Anshul Gupta, Co-founder and Chief Investment Officer, Wint Wealth.

 

In justification of ‘withdrawal of accommodation’ stance, the RBI governor linked the stance to the RBI’s inflation target and policy transmission. The governor highlighted that CPI inflation is still above the RBI’s 4% goal and the transmission of past monetary policy actions is still incomplete in the credit market. On inflation, the RBI seems more worried about volatile food prices and uncertain food inflation outlook

The RBI has raised the repo rate by 250 bps since May 2022. However, this has not been completely transmitted to lending and deposit rates. " The deposit rate, which was steady for the last three months, rose 5 bps in January and vehicle loan rates increased 2 bps. On the other hand, money market rates have risen at a faster pace than the repo rate due to tighter systemic liquidity, which has driven up rates over the past few months," said rating agency Crisil in a note.

Moreover, the liquidity deficit in the banking system shrank to about Rs1.40-lakh crore on February 4 from the peak of Rs 3.46-lakh crore (on January 24) in view of the government stepping up spending.
 

What does this mean for the bond market? 

Crude prices have fallen despite the crisis continuing in the Middle East and global bond yields have retracted sharply from their highs over the course of the last couple of months. Till the financial year end (March 2024), RBI is likely to focus on liquidity management and macroeconomic stability. 

"Due to tightness in liquidity, the short-term rates are also very lucrative. One year, government papers are giving 7% plus rates, which are much higher than the savings account rates that large banks are offering. Investors can shift money needed for near-term goals to these short-tenor papers," said Gupta.

"We continue to believe that rate cuts in India will start from the third quarter of calendar year 2024 onwards. Bond yields tend to react in advance of the start of a rate cutting cycle and thus we believe it is the right time for investors to start increasing their allocation to Fixed Income, especially at the longer end of the curve.Investors with medium to long term investment horizon can consider funds having duration of 6-7 years with predominant sovereign holdings as they offer a better risk-reward currently. Investors having an investment horizon of 6-12 months can look at Money Market Funds as yields are attractive in the one-year segment of the curve. We expect the benchmark 10yr Bond yield to gradually drift lower towards 6.50% by Q3 CY2024," said Puneet Pal, Head - Fixed Income, PGIM India Mutual Fund.

Sovereign bond yields have declined since the December 2023 MPC meeting with the benchmark 10-year yield falling by 20 basis points to 7.07% while 30-year IGB yield easing by 30 bp to 7.13% after the policy outcome. "IGB yield curve has experienced “bullish flattening”. With spreads between the 10 & 30-year IGB at historic low, we believe value is gradually emerging in the 10-year segment of the yield curve. We expect benchmark 10-year IGB to gradually trend towards 6.90% level first by mid-2024 and then towards 6.75% after the commencement of the rate cut cycle," said Dhawal Dalal, President & CIO - Fixed Income, Edelweiss Asset Management Limited -

Dalal thinks investors should consider increasing duration in their fixed-income portfolios through sovereign bonds maturing in the 10-year segment amid historically tight spreads on the long end. 

"We expect short term money market rates to remain elevated due to tight liquidity environment. This should be supportive for liquid funds that rely on interest accruals on short term debt instruments. For the bond market, outlook remains positive supported by falling inflation trend, possibility of rate cuts, global bond index inclusion and favorable demand supply mix. Investors with 2-3 years short-term horizon can consider dynamic bond funds to potentially benefit from the falling bond yields. Conservative investors with shorter holding period should stick with liquid funds," said Pankaj Pathak, Fund Manager- Fixed Income, Quantum AMC.

Dynamic bond funds are debt mutual funds which invest across durations. These schemes alter the tenor of the securities in the portfolio in line with expectations on interest rates. The tenor of these funds is increased if interest rates are expected to go down and vice versa. A liquid fund is an open-ended debt mutual fund that invests in debt securities with a maturity of fewer than 91 days.The fund portfolio invests in debt instruments that are of high credit quality. They invest in money market instruments like certificates of deposits (CD), treasury bills(T-bills) and commercial paper (CP) for up to 91 days.

"Interest rate risks can be used to generate higher-than-usual returns. Long-term funds have the highest risk and so the highest returns possibility. You can go 12% one year and then fall to 1-2% the next year. So it's probably a nice short-term play. If you don't like that much risk and just want steady returns, try short-term funds like liquid which will stay somewhere close to FD returns every year," said Adhil Shetty, CEO of Bankbazaar.