Weekly View on Fixed Income markets by Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund

Below the Weekly View on Fixed Income markets by Puneet Pal, Head-Fixed Income, PGIM India Mutual Fund
Continue to allocate to Corporate Bond Funds having portfolio maturity up to 6 yrs
Our View
The inflation trajectory is likely to undershoot RBI’s projections for FY26 and we expect one more policy repo rate cut in the Oct-Dec quarter. RBI’s focus is on effective transmission of the policy rate cuts, resulting in lower lending rates. This means that RBI will keep the banking liquidity easy. We believe that the AAA corporate bond curve of 3-6yrs maturity segment presents a decent investment opportunity in the current circumstances. The current spread of 60-70 bps between the AAA 5yr maturity PSU bond with the corresponding maturity G-Sec is attractive from a historical spread perspective, especially given that the banking system liquidity will remain in surplus. The longer end of the curve (30yr) also presents a short term tactical opportunity as yields at the longer end are unchanged over the last one year and also from the beginning of the CY25 which can result in value buying.
Investors can continue to allocate to Corporate Bond Funds having portfolio maturity up to 6yrs while being tactical in their allocation to duration through Dynamic Bond Funds. Investors should have an investment horizon of 12-18 months while investing. Money market yields of up to 1yr are also looking attractive from a relative risk-reward scenario for investors with short term investing horizon and investors can look to allocate in that segment also. We expect the 10yr bond yield to trade in a range of 6.10% to 6.50% over the course of the next one month.
Indian Markets:
Bond yields inched higher during the week as market remained uncertain about the rate cut trajectory in spite the lower inflation projections. The entire curve moved up by 5-6 bps. The benchmark 10yr bond yield ended the week at 6.35%, up 5bps from the previous weeks closing (6.33% GOI 2035). Yields had been stable and had come down in the week prior but the market gave up all the gains as the RBI governor again stated that bar for further easing is high and near term inflation trajectory can be overlooked on the last day of the week.
This in spite of the fact that in all probability inflation is likely to average around 3.30% - 3.40% in FY26 below RBI’s forecast of 3.70%. RBI is focussing perhaps on “Core Inflation” which has inched higher. Food inflation is likely to be contained and we have seen cereals, pulses and spices’ prices fall as rabi crop has been good and Kharif sowing also has been good.
The central bank’s move to nudge the overnight lending rates closer towards the policy repo rate through Variable Rate Reverse Repo (VRRR) auctions led to tightness in the overnight lending markets with Treasury Bills Repurchase (TREPS) rate going up to a high of 5.70%-5.80%, which resulted in a course correction with RBI announcing VRR auction to ease the pressure on overnight rates. Overnight rates normalized with RBI rolling over only INR 1.25 trn in VRRR auction on Friday compared to the VRRR maturity of INR 2 trn. The government also announced buyback of INR 300 bn for this week which should keep liquidity surplus above INR 3 trn.
Monsoons remained surplus and till July 25, cumulative rainfall was 5% above long-term average while weekly rainfall was 10% below long-term average. On a cumulative basis, rainfall was above-normal in North, West, Central and South India while below-normal in east India. Out of the 36 sub-divisions, eight have received deficient rainfall, 12 have received normal rainfall, and 16 have received excess rainfall. Basin-wise reservoir levels has remained in surplus. Overall basins and reservoirs levels were 53% above long-term average for week-ending July 24. The OIS curve also ended the week higher by 3bps with the 1yr OIS yield at 5.53% and the 5yr OIS yield at 5.73%. INR weakened to 86.52 from 86.16. Brent crude was marginally lower, ending the week at 68.44 compared to last week’s closing of 69.28. FPI inflows into debt continued to be positive for the month with close to USD 1bn of inflows so far in this month. Money markets rates were stable during the week with 3 month maturity CDs trading in a range of 5.75%/5.80%.
International Markets:
Globally, bond yields remained stable with key meeting of the US Fed and the Bank of Japan lined for towards the end of the month. Both the BOJ and the US Fed are expected to retain the status quo on policy rates. The US bond markets are factoring in close to 100 bps of rate cuts over the next one year.
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