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Below is the views on Quantum Fixed income Team By Mr. Pankaj Pathak, Fund Manager-Fixed Income
Quantum Fixed income Team
Bond yields across all the market segments and maturity profile trended up in the past month mainly due to surge in crude oil prices and increased supply of government debt in weekly auctions. The 10 year sovereign bond ended the month at 7.41% vs 7.32% in the previous month.
In addition to the upward shift the yield curve also witnessed a flattening as the yield on shorter maturity bonds jumped by higher proportion than longer maturities. The yield on 3-5 year maturity bonds moved up by 25-40 bps as against 9 bps on the 10year bond.
The money market had a divergent trend through the month. The yield on 1-2 month PSU securities dipped to near 6.7% for short period at start of the month but rebounded sharply towards the month end to close near 7.3%. This was partly due to tight liquidity conditions though it’s also reflective of the ongoing concerns in the credit market.
The credit market remained in tough spot with credit risk rising in the aftermath of the IL&FS default. There have been series of rating downgrades/defaults which negatively affected various debt mutual funds schemes and thus dampened the investors’ sentiment. The impact of it was not limited to the lower credit space as good quality liquid issuers also witnessed selling pressure and rise in cost of funds. Good quality PSU papers of 1-2 months maturities are now trading at unusually high spread of over 130 bps above the overnight repo rate. We find these levels attractive for good credit quality money market papers though we maintain our negative stance on the credit market.
For long maturity bond yields, the larger focus will remain on the crude oil prices, demand supply dynamics and the RBI’s monetary policy. Moreover, election results and monsoon patterns can also affect the direction of bond yields.
The crude oil has been on upward path since start of this year amid supply reduction from the Saudi and Russia led cartel of oil producers. Apart from this political turmoil in Libya & Venezuela and sanctions on Iranian oil imports have also created upward pressure on the prices. The brent crude oil price rose by over 33% in the last four months and currently trading near USD 71 per barrel.
We cannot rule out a possibility of further rise in the crude oil prices especially if the market moves away from the Iranian Oil supply. However, we are of the view that any spike in oil prices from here will be temporary as slowing global economy and excess capacity with the OPEC members will put downward pressure on the prices.
The other major determinant of bond market will be demand supply dynamics which will be largely dependent on the RBI’s open market operations (OMO) and foreign investment flows. Recently the RBI has introduced a new liquidity tool long term USD/INR swap which is an alternative to OMOs for managing durable liquidity in the banking system. After conducting two back to back 3 years FX swaps of USD 5 billion (~INR 350 billion) each in March and April, the RBI has now announced to conduct OMOs worth Rs. 250 billion in the month of May. Future demand supply dynamics in bonds will be dependent on evolving liquidity situation and the RBI’s choice of instruments to manage that.
On the monetary policy, we have changed our outlook after the minutes of the MPC meeting held on 2-4 April 2019. Now we expect further 25-50 bps cut in policy repo rates in coming quarters. The minutes indicate that the slowing economic growth momentum has taken a Centre stage in policy formation. The tone of most members appeared tilted towards supporting growth. There were differing views on the inflation outlook but is broadly seen under the RBI’s 4% target.
At 6% Repo Rate, the 10 year government bond yield near 7.4% looks attractive from a valuation standpoint. However, the uncertainty on oil prices and on the election outcome may cause some near term volatility in the bond yields.
Investors in bond funds, as always will have to remain aware of the near term volatility in interest rates and invest only with a view of over 2-3 years. As mentioned above, Oil prices and Election outcomes will now hold sway and although long term bond yields are attractive from a valuation standpoint, but its direction in the short term is uncertain.
Dynamic Bond Funds, which allow the fund manager the flexibility to change the portfolio positioning depending on the emerging situation is a better alternative if you wish to allocate to bond funds. While choosing a debt or money market fund, investors should prefer funds which take low credit and liquidity risks.
Quantum Liquid Fund (QLF) prioritizes safety and liquidity over returns and invests only in less than 91 day maturity instruments issued by Government Securities, treasury bills and top rated PSUs.
Quantum Dynamic Bond Fund (QDBF) takes higher interest risks, but does not take any credit risks and is invested only in Government Securities, treasury bills and top rated PSU bonds.
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