Last week we had discussed a list of factors currently in play for Indian bond markets (refer “Inventory of Factors: A Macro And Bond Assessment”, dated 18th August). Amongst the positives mentioned was RBI’s focus on core inflation and thus lack of MPC urgency to hike rates. The same had been reaffirmed at the recent monetary policy review with MPC members generally seeing little signs of generalised inflation and RBI scaling down its core inflation forecast for the year. This, apart from the FCNR flows (and related demand for bonds), has been an important anchor for us and the market, in what is otherwise a very uncertain world. Given this anchor, we were okay to assume that bond market volatility would remain rangebound thereby allowing us to run positions and wait to see whether some of the other potential constructive factors will strengthen in their influence (softer US data leading to paring back of rate hike expectations, as an example).
However, the recently released minutes of the last RBI policy have shaken market assumption of a benign MPC. Thus, while the day of the event itself had left a general impression that both ‘if’ and ‘when’ are in play as far as future rate hikes are concerned, the minutes seem to be leaning more in direction of ‘when’ while underplaying the ‘if’. Once the market gets to the point of actively considering rate hikes, as it has, then both the quantum and timing start getting continually reassessed. A case in point: our own expectation so far with respect to rate hikes has been ‘not more than 50 bps’. However, at the time of writing, we are no longer sure whether 50 bps cannot eventually be 75 bps, or whether October policy should not be considered ‘live’ for the first hike (well begun is half done, being as sound a ground for this expectation as any).
Dialling Back
For most of this year, we have had to run duration actively. This is largely owing to a very uncertain world (continued commodity and global yield volatility) and a starting relatively bearish local construct (‘Impossible Trinity’ pressuring local financial conditions limiting transmission of RBI policy to market rates). From time to time, we have added duration based on more near-term balance of risks, some hope that potentially medium-term bullish factors may be emerging, and with market valuations getting cheaper. At the same time, the ‘shelf life’ of these positions has been more uncertain than usual, given the environment and underlying construct.
Basis the reasons assessed above, we have again dialled back on duration across a host of our funds (subject to individual mandates and positionings). The primary route for doing so has been reducing long duration government bonds. Relative valuations here versus shorter tenor government bonds still look fine. The base case for us is that the government bond curve will relatively flatten from here over the few months ahead as the FCNR related buying tapers off and market starts positioning for RBI rate hikes. That said, this is more an argument for holding long end on a duration adjusted basis since the relative rise in yields here may be slower than at front end points. However, as investors we need to manage overall duration risk as well and hence the case for paring long end positions on a stand-alone basis. The incentive for doing so has been stronger since market yields are yet within the range they have traded in since late June. As always, this represents our thoughts and positioning at this time, and these can change in the future depending upon evolution of factors we are tracking and / or changes in our own thinking.
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