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 Below the Debt Market Outlook by Puneet Pal, Head- Fixed Income, PGIM India Mutual Fund. 

10 yr benchmark bond may trade in a range of 7.10% to 7.30% over the next  one month

The bond yield curve flattened in the last month of the year as short-term yields rose marginally and long end yields came down after  the policy pivot by the US Fed. The 3-5 yr segment of the bond curve outperformed. Money market yields up to 1 yr segment inched  higher as banking system liquidity remained tight with RBI injecting short term liquidity into the market via variable rate repo (VRR)  auctions. The key reason for the tightness in interbank liquidity has been a very high government surplus. In our estimates, currently,  the government is running a surplus of around INR 3 trn. The government surplus will come down over the next three months on back  of higher spending which can lower the liquidity deficit. Bond yields at the long end of the curve came down after the US Fed policy  meeting as the Fed policy pivoted to a pause. The RBI MPC policy was on expected lines as status quo on rates was maintained though  RBI reiterated its concern on food inflation while acknowledging the downward trajectory of core inflation. Bonds yields came down at  the long end of the curve in sync with the fall in US and European bond yields though the fall in Indian bond yields has been muted relative to the fall in US and European bond yields.

Brent crude oil also fell by 7% as concerns remained on the demand outlook. CPI inflation came in at 5.55% and the core inflation  came in at 4.10%, a 44-month low, which is heartening given the strong growth dynamics. Food inflation, especially pulses, remained  elevated. RBI’s intervention in the FX market found mention in IMF’s annual review, which re-classified India’s foreign exchange policy  from floating to stabilised arrangement on account of excessive intervention by the RBI since December 2022. RBI strongly rebuked  this observation suggesting that the time frame concerned was too short to make an assessment and any policy needs to be seen over a  longer time frame of 3 to 5 yrs. Going by the numbers released in RBI’s latest monthly bulletin, it seems RBI has been intervening pretty  heavily in the FX market. RBI’s gross intervention (buy and sell combined) was the highest ever in October, standing at $ 73 bn, with  $ 36 bn intervention both on buy and sell. RBI’s intervention in the FX futures and forward market has risen, and RBI’s forward book  went into negative zone at $ 14 bn, the first negative forward position after more than 3 yrs. This shows that the preference of RBI’s  intervention in the FX market has shifted from spot to forwards and futures. FPI inflows in the bond markets have increased post the  announcement regarding the inclusion of Indian sovereign bonds in the JP Morgan GBI-EM Index to the highest in 6 yrs. In CY 2023,  FPI debt inflows totalled at $ 7.27 bn, with $ 4.80 bn coming in last three months post the index inclusion announcement. The current  account deficit moderated to 1% of GDP in Q2 FY24 compared to 1.1% of GDP in Q1 and 3.8% of GDP in Q2 FY23. The BOP surplus  was modest at $ 2.60 bn in Q2 FY24 compared to $ 24 bn in Q1.

The OIS curve has outperformed the sovereign curve in December with the 5 yr OIS falling by 33 bps as compared to the 11 bps fall in  the benchmark 10 yr bond yield. The yield of the 5 yr bond fell by 18 bps during the month. INR was stable ending the month at 83.21  appreciating 19 paise from its all-time low closing against the USD in November.

Global bond yields led by US treasury yields came down across the curve with the benchmark 10 yr US yields down by 45 bps. The  narrative of soft landing took hold with softer inflation data along with slowing growth. The US bond market is pricing in 150 bps rate  cuts during 2024, which might prove to be optimistic given the cautious Fed stance amidst strong growth. RBI is likely to start cutting  rates only after the global rate cutting cycle starts, which in our view, is likely to happen from Q2/Q3 of CY 2024 onwards. Markets tend  to react before the start of a rate cutting cycle and the current yields offers a good opportunity for investors to increase their allocation  to fixed income as slowing growth and moderating inflation is likely to lead to rate cuts in 2024.

We expect the 10 yr benchmark bond to trade in a range of 7.10% to 7.30% over the next one month.

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