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Below are Views On Fixed Income Monthly Commentary – Novemeber  2021 by Pankaj Pathak, Quantum Mutual Fund

The bond market selloff of late September continued in October. During the month, the 10-year benchmark government bond yield (Gsec) surged 17 basis points from 6.22% on September 30, 2021, to 6.39% on October 29, 2021.

Since September 20, 2021, the 10-year government bond yield has moved up by a cumulative 24 basis points. At the shorter end, the impact was even more pronounced as yields on 1-3 year maturity government bonds jumped by about 35-40 basis points during the same period.

Much of the selloff can be attributed to two developments – (1) a steep rise in crude oil price and (2) a normalization of liquidity operations by the RBI. The crude oil price has been rising for the last two months due to the pick up in global demand and restricted supply by the oil producers’ cartel – the OPEC and Russia. The Brent oil price has jumped by ~18% in the last two months and currently hovering near its 2018 peak of USD 86/barrel.

If supply is not raised quickly, crude oil prices will remain under pressure which poses a risk for Indian bonds. The RBI has been normalizing its liquidity operation since the start of this year with staggered re-introduction of variable-rate term reverse repos (VRRR). This was on expected lines and was more or less priced in the market.

However, total liquidity absorption under VRRRs increased significantly during the last month, which in turn led to a sharp reduction in the overnight surplus liquidity with banks. At the same time cutoff yields on the VRRR auctions also moved higher between 3.75%-3.99%.

The sharp jump in the money market rates inflicted to the front end of the bond curve and pushed yields higher. There is also an expectation of a hike in the reverse repo rate in the upcoming monetary policy review in December 2021.

Although the macro backdrop is unfavourable, valuations at both the short and long end of the curve have improved significantly after the sell-off. We particularly like the 3-5 year segment of the government bond market which in our opinion, is already pricing much of the liquidity normalisation and a start of rate hiking cycle by end of this year. Given the steep bond yield curve, 3-5 year bonds offer the best roll down potential as well.

At the longer maturity segment, current yield levels look good from a perspective that the terminal repo rate in this cycle may remain much below its pre-pandemic normal level. However, we are restricting exposure to the longer segment due to risk from the rising crude oil prices and the absence of assured RBI buying.

Currently, a bulk of the QDBF portfolio is positioned in the 2-5 year space which is reflective of our aforesaid view on the bond market.

In the current juncture, we believe a combination of liquid to money market funds to benefit from the increase in interest rates in the coming months; along with an allocation to short term debt funds and/or dynamic bond funds with low credit, risks should remain as the core fixed income allocation.

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