Over the recent few days, global macro complexity seems to be on the rise again. The reason we use the word ‘complexity’ instead of ‘deterioration’ is that not all is bad, even though a cursory reading of things would tend to readily counter this sentiment. Thus, a useful thing to do could probably be just to list out the various factors at play, without claiming that the list is comprehensive or the inference presented here cannot be countered. It is also to be noted that the observation and assessment here is from the narrow context of Indian bonds alone. This is the context used when we classify factors below as ‘positive’ or ‘negative’.
Negatives
- Reescalation on Middle East tensions: At the time of writing, Brent is back above USD 90 per barrel and there seems to be little clarity on any sort of a significant resolution to the issue. While the intensity of active escalations may have reduced, the macro-economic squeeze via the commodity channel persists. That said, oil prices could have been even higher but for some demand destruction and the probability that traffic flow via Strait of Hormuz may be higher than what is getting recorded.
- Continued pressure on global bond yields: Bond yields continue to be under pressure. Japanese 30 year is back to May highs, while their US counterpart has even breached that watermark. The rising debt intensity of AI capex and incremental deterioration in US fiscal dynamics with tariff refunds underway, seem to be contributing to the pressure on long end rates, apart from Fed policy uncertainty.
- Premature closure of FCNR window: The RBI has decided to close the FCNR swap window one month early, for deposits mobilised till 31st One can see where they may be coming from: this is a temporary, subsidized fix with clear costs attached and very firmly prone to diminishing marginal utility. Thus, if the requisite amounts are in, there may seem little point continuing with the window. At the same time, there is something to be said for striving for policy predictability and sensitivity to hidden costs of abrupt changes. This is especially so when global macro uncertainties are very high currently.
Positives
- US economic data has turned softer: Recent US data across jobs, spending, and inflation have all come in weaker than expected thereby taking some pressure off from Fed rate hike expectations. While this has shown in dollar weakening, the yield curve continues to steepen with long end rates making new highs.
- China domestic growth momentum has turned down: A spate of China domestic data recently has come weaker than expected. Weaker domestic demand in the second largest economy continues to be an important counterpoint to inflationary pressures emanating from the largest one. China’s weaker demand seems to have also put some lid to oil prices in this phase of geo-political escalations.
- Continued immunity to higher global rates seems to be faltering in pockets: The contribution of higher mortgage rates to subdued housing markets is well established. Lately, the discussion around stress in pockets of global private credit seems to be also gaining ground. This pertains to both business model pressures from AI as well as effects of refinancing pressures at much higher rates. We acknowledge little direct insight here but, nevertheless, think of this as one area to monitor from the standpoint of rising rate sensitivity. More generally, one cannot help but wonder that at some juncture rising yields may start to pose a headwind to the pace of debt financed AI build out, even as borrowings to fund this build out may be a key reason why long end rates are going up in the first place.
- RBI’s focus on core inflation: While headline inflation pressures have been apparent, RBI’s focus remains on core inflation as a better gauge for measuring underlying inflationary dynamics. To be clear, this doesn’t mean that the target has changed but only that the central bank is looking for more reliable indicators to assess medium term inflation given the heightened current volatility in food and fuel prices. With the central bank having recently scaled down in core inflation forecast, assessing little signs of generalization thus far, we continue to expect a very shallow rate hike cycle at best (not more than 50 bps). Given this expectation, bond valuations in our preferred segments look good to us.
Conclusions
An added point of comfort has been an unequivocal policy recognition in India that capital flows need stepping up. While this has manifested in more short-term fixes thus far (hedge cost subsidies and bond tax cuts), one also looks forward to meaningful measures to attract longer term capital. If forthcoming, they will help settle the narrative on the rupee somewhat. This has been wanting thus far despite the FCNR scheme. For India bond dynamics to sustainably turn favourable, we will also need some help from the global narrative. The obvious two here are some easing of pressures on oil (Middle East de-escalation) and global rates. The latter may need the recent soft patch in US data to continue as well as some easing in pace of AI capex.
While the list of asks seems large, some of the factors discussed above point to signs of hope. Meanwhile, a combination of local policy support for dollar flows, a relatively benign view on RBI rate hikes, as well as some unwind in US rate hike expectations recently, will hopefully keep bond market volatility within tolerable ranges for the time being. This allows for some patience to remain invested and see whether other global tailwinds materialise or not. This is the approach we are taking as of date, continuing with our preferred segments of up to 3 – 4-year corporate bonds and long duration government bonds.
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