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Below the Quote on Debt Market Outlook by Jalpan Shah - Head Fixed Income, TRUST MUTUAL FUNDS

 Wrap up of debt market in August 2024

The month of August-24 began on a very volatile note. The Bank of Japan (BoJ) hiked interest rates by 25 bps as inflation continued to remain higher and to arrest the weakening of the Yen against the dollar. The labor market data released for the month of July-24 in the US was much weaker than expected. This raised concerns of a faster slowdown in the US and markets started pricing in accelerated rate cuts by Federal open market committee (FOMC) for this year. The weaker labor market data coupled with tighter BoJ policy resulted in unwinding of Yen Carry trades, which led to sharp volatility in risk assets across the globe and a significant drop in yields for all major economies.

Later in the month, The Federal Reserve Chair J. Powell in his speech in Jackson hole emphasized that the restrictive policy by the FED had been successful in bringing down inflation towards its 2% goal and that labor markets will now be the focus for the FED.    

The Monetary Policy Committee (MPC) in its policy on Aug-24 decided to keep the repo rate unchanged at 6.5%. The stance of the policy also remains unchanged at ‘withdrawal of accommodation’. Both the policy rate and the stance was kept unchanged by a majority vote of 4:2. Two members of the MPC, like in the Jun-24 policy voted for a 25bps cut in Repo rate and a change in stance of the policy to ‘Neutral’.

The tone of the policy was ‘mildly hawkish’.

Domestic Growth continues to be resilient with no change in FY25 projections at 7.2%. Expansion in service sector activity, ongoing revival in private consumption, high-capacity utilization, healthy balance sheet of banks and corporates and Governments thrust on infrastructure spending points to robust growth outlook.

On the inflation front, while there was some comfort on the core inflation coming down, the spike in food inflation has caused headline inflation to remain above 4%. The 2^nd quarter FY25 inflation projection by Reserve Bank of India (RBI) was revised up by 60 bps to 4.4% since the last policy but the FY 25 projections remained unchanged at 4.5%. The governor emphasized the need to focus on its disinflationary stance and on price stability to achieve a sustained period of high growth.

Subsequently, the inflation for the month of July came in lower at 3.54%, largely due to favorable base effects.

* Near term outlook for debt markets

We remain constructive on fixed income markets. The global backdrop is turning favourable for the rates markets with markets pricing in 100 bps of rate cuts by the Federal Reserve in this calendar year and additional 125-150 bps of rate cuts in 2025. Domestically, while the high frequency data has been pointing to a robust growth rate, we will see certain moderation in the last quarter of FY25 and early FY26 due to tighter lending norms by banks and NBFCs. We are witnessing certain pockets of stress building in the unsecured lending segment, and this is where the lenders will tighten up their lending standards.  Inflation is likely to moderate on the back of a good monsoon helping cool-off the perishable components of the food basket while the core inflation will broadly remain in control. This will pave the way for a potential rate adjustment starting from 4^th quarter of FY25.

* Expected range of 10-yr-g-sec and outlook on short end of the curve

We expect the 10 year Gsec to trade in the range of 6.70- 6.90 in the near term with a potential downside in yields towards 6.50% in the medium term.

* Which category of funds should distributors recommend to their clients in current markets and why (E.g., short-term, medium term or duration)

   Conservative investors can look to invest in fund categories like short duration, medium duration, Banking and PSU debt funds and corporate bond funds operating in a duration band of 2-4 years. High quality funds in these categories offer a good mix of Bonds and GSecs.

Currently the spreads on AAA bonds over G-secs are quite attractive. Investors can take advantage of this by investing in the above fund categories over a short to medium term. G-Secs are positively placed due to the favorable demand-supply dynamics.  

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