Published on 9/11/2017 5:02:28 PM | Source: Quantaum Mutual Fund

Debt Outlook By Pankaj Pathak Fund Manager Fixed Income Quantum Liquid Fund & Quantum Dynamic Bond Fund

Posted in | #Mutual Fund #Pankaj Pathak

Indian Bond yields continued its bearish upward trend in October. The 10 year Government Bond yield rose by 20 bps to end the month at 6.86%. Bond yields have now inched up by more than 40 bps since the August monetary policy where in it had bottomed at 6.4%. A combination of hawkish RBI statements, rise in US treasury yields, general increase in price of Oil and other global commodities and worries on the fiscal deficit has led to this increase in market interest rates.

The move up in October also started with the RBI policy being perceived more hawkish than warranted. Market participants were not expecting any rate cuts but had expected the RBI to lean towards supporting growth on the back of weak GDP numbers. The RBI commentary though was tilted more towards the risks of inflation going above the 4% headline CPI target. The RBI now forecasts CPI inflation to be at 4.2% - 4.6% by March 2018 but this includes the technical impact of increase in House Rent Allowance and the short term impact of GST. We believe the RBI should strip off the HRA increase and should then determine the headline CPI trend which pegs below the 4% target. The markets have now completely given up expectations of rate cuts and in fact the RBI minutes suggest that Dr. Patra (ED, monetary policy) has once again remarked about the RBI to be ready to hike policy rates.

The other major reason for the bearishness has been the dilly-dallying by the government on meeting the fiscal deficit target for this fiscal year ending March 18. Lower Growth numbers were interpreted to convey that the government will announce a fiscal stimulus. Various comments by finance ministry ‘sources’ since flashed on the news wires have been around large revenue shortfall and that the government will try to not to breach the deficit target but will take the final call in December.

The government announced a bank recapitalization plan to infuse equity capital of Rs. 2.11 trillion into public sector banks; out of which Rs. 760 billion will be in the form of direct budgetary support from government and capital rising by banks in market and the rest Rs. 1.35 trillion will be through Bank Recapitalization Bonds. The applications of these bonds are yet to be disclosed which leaves us with many   possibilities about its impact on fiscal deficit and market demand-supply. Going forward market will look out for details about the structure of these bonds and guidance on government’s fiscal plans. On global front European central bank (ECB) acknowledged the ongoing improvement in economic activity and announced the plan to reduce its monthly asset purchases from EUR 60 billion to EUR 30 billion starting January 2018. US treasury yields have also risen meaningfully due to renewed expectation of tax reforms and improved economic data. We expect that the developed markets central banks will continue to follow the gradual tightening of monetary conditions without distorting the financial markets.

The liquidity surplus with commercial banks registered a significant decline during the last month due to increased cash withdrawals ahead of festive season and lower government spending. Despite this fall, the liquidity situation still remain in surplus of close to INR 1 trillion which help keeping the short term money market rates close to repo rate. Going by the historical trend of currency in circulation we expect liquidity to move close to neutral by Q1 2018.

At the current levels with most of the bond yield curve closer to 7%, we believe that most of the adverse news impact on markets would be negligible as markets have considered them already, levels remain attractive. On the fiscal front, we would actually worry more about the government’s commitment to next year’s (FY 19) fiscal target and if the government increases the fiscal deficit target next year then we would expect further increase in bond yields. Else, based on our expectation of muted inflation but no rate cut expectations, we expect the bond yields to range in the 6.65%- 6.90% level. We remain overweight duration in Quantum Dynamic Bond Fund at the current levels given the term spreads, the illiquidity premiums and the steepness of the yield curve.


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