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Below the Views on Weekly Fixed Income by Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund

Bond Markets Await December Rate Cut as Yield Curve Steepens

Our View:

The optimism following the dovish October MPC meeting has faded completely, with yields at the longer end of the curve rising continuously—even after RBI’s verbal and OMO interventions through NDS-OM. Concerns around adverse demand–supply dynamics and uncertainty over the future monetary policy path have significantly contributed to the current slump in bond markets. Markets will be looking closely at the upcoming MPC meeting on December 5 for clear signs of strong RBI intervention to address persistent supply pressures and to firm up expectations regarding the terminal repo rate.

Investors can continue to allocate to Corporate Bond Funds with portfolio maturities of up to 5 years, while taking a tactical approach to duration through Dynamic Bond Funds. Investors should maintain an investment horizon of 12–18 months. Money market yields of up to 1 year also appear attractive from a relative risk–reward perspective for investors with short-term horizons, and allocation in this segment can be considered.

We expect the MPC to cut the policy repo rate by 25 bps in the December meeting. We expect the 10-year bond yield to trade in a range of 6.35% to 6.65% over the next month.

Indian Markets

Bond yields have been range-bound so far this month as bond markets grapple with adverse demand–supply dynamics, especially at the longer end of the yield curve, amidst historically low CPI inflation, which has made another repo rate cut almost a done deal. The yield curve continues to steepen, with the longer end underperforming. Yields at the longer end have risen sharply over the last month. Yields for maturities greater than 30 years have risen by almost 24 bps since mid-October.

The enthusiasm following the dovish MPC meeting on October 1 has faded due to lacklustre demand for longer-duration securities, despite the historically low CPI inflation of 0.25% for October. The previous month’s CPI inflation was also revised lower to 1.44% from 1.54%. Food prices continue to drive inflation lower, though the GST cuts have also contributed to the softer October print. “Core inflation” was flat at 4.30%, though the September estimate was revised lower to 4.40% from 4.60% as the housing component was corrected.

Inflation in the current quarter is tracking almost 100 bps below RBI’s forecast of 1.80% (YoY) for the quarter, which builds a strong case for a rate cut in the December policy. WPI inflation turned negative at -1.21%, with lower food prices—especially vegetables—contributing significantly. Given the persistent undershooting of inflation relative to RBI’s forecast, monetary easing appears likely, and we believe the stage is set for a rate cut in the December MPC meeting.

The RBI, informally expressing uneasiness with the rise in yields, cancelled one auction of INR 110 bn at the start of the month. The RBI also began OMO purchases of G-secs in the secondary market through the NDS-OM system, totalling about INR 125 bn up to the week ended November 7. This resulted in a brief relief rally, which quickly unwound, indicating that the market will need continuous RBI support to manage the excess supply.

RBI’s intervention in the FX markets continued, and the INR traded in a very tight range. FPI inflows into the bond markets remained strong, with USD 696 million in flows so far this month.

The OIS curve also steepened, as the 1-year OIS yield remained steady at 5.47%, unchanged from the start of the month, while the 5-year OIS has risen 7 bps to 5.74%. Money market liquidity has eased considerably over the past week on the back of government spending, with 1-month CD yields falling by 5–10 bps and currently trading around 5.75%. Three-month CDs are trading around 5.95%–6.00%, while 1-year CDs are at 6.40%–6.45%. The fall in 3-month and 1-year CD yields has been muted as markets remain unsure about the future liquidity scenario.

International Markets 

The US Fed, after cutting rates in October, is now sending hawkish signals, leading markets to reduce the probability of a December rate cut. Fiscal concerns continue to linger in France and the UK.

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