Bond market sentiment remains largely muted, continuing the reasonable long stretch from the June MPC meeting which delivered the larger than expected rate cut but also a change in stance to neutral. To recap, RBI/MPC have front loaded rate and liquidity easing in order to jumpstart the transmission process. With a view to caution against overreliance on incremental monetary policy action, the stance was changed. However, subsequent communication seems to be emphasizing forward looking inflation and the literal translation of the new stance which is that rates can be cut, held, or hiked. With a forward CRR cut still pending, RBI still wanting transmission, and a growth slowdown underway, it is not perhaps entirely desirable to so actively counter the expectations channel which, after all, is also an important channel of transmission.
To be fair, the global rate environment has also not been conducive during this period. Fiscal and inflation worries continue to haunt US and Japanese bonds. While the rate cut debate has turned quite lively in the US, and indeed growth data under the hood isn’t looking all that rosy, the Fed is nevertheless worried about tariff impact on inflation for the time being. This is understandable given the recent history of inflation in the US, and yet sets the Fed at risk of falling behind the curve should tariff price impacts not generate any meaningful second order inflationary effects. While in theory the Fed can wait and cut, in practice it is well aware of the long and variable lags with which monetary policy works.
All told, and despite recent developments, we remain constructive on the fixed income market for the following reasons:
- The long phase of ‘dollar dominance’ seems to be on hold for the time being with some medium-term drivers of the so-called US exceptionalism turning, the economy slowing, as well as owing to policy related volatility.
- Despite fiscal concerns, we do expect US bond yields to eventually ease reflecting the cyclical slowdown and the subsequent Fed response. While the floor on US rates may be higher owing to higher deficits, there is enough room for yields to move lower on a cyclical basis, in our view.
- With US slowing, Europe’s fiscal expansion being negated by currency strength, and China having upfronted a lot of exports in first half of the year ahead of the tariffs, we expect global growth to slow. This will have some effect on India’s growth as well. Our domestic demand seems to already have hit a soft patch as evident in growth rate of nominal variables, recent company commentaries, and bank credit slowdown. With respect to credit growth, corporate demand is patchy and parts of retail lending are showing more stress thus inviting caution from lenders. Thus, the credit growth slowdown may have some legs before it sustainably turns. In the meanwhile, we expect banks to grow their investment books especially as bond term spreads remain so high.
Given the above, we continue to believe that RBI’s turn of commentary is somewhat premature. Put another way, we aren’t yet sure that even the rate cut cycle is fully over. Any turn towards a hike is a long time away. Thus, in our view, it is quite curious that RBI / MPC already wants the optionality for a hike. Therefore, we find the retracement in yields as an opportunity for fixed income investors.
Bond Strategy Update
Our active bond and gilt funds have been very overweight (close to 100%) 30 year government bond (2053 maturity). Given both structural and cyclical tailwinds, as well as attractive valuations, our approach has been to optimize duration. However, there have been some recent developments on the yield curve that have led us to partly revisit the strategy. The logic of the change, as well as the change itself, is summarized below:
- Given the view expressed above, we remain focused on running a high level of duration. Thus, the starting point is that any change of strategy should not lead to any meaningful cut to duration at this juncture.
- The yield curve has generally steepened from June reflecting market sentiment has discussed above. However, the steepening hasn’t been uniform across the curve. The chart below shows how the spreads between 15 year and 10 year government bonds and those between 30 year and 15 year government bonds have moved since early June.
As can be seen, the bulk of the widening has happened between 15 year and 10 year segments. Net supply in the 10 year and around tenors has been limited owing to RBI bond purchases. Thus, the brunt of the bearish sentiment had to be borne by the 15 year. 30 year minus 15 year spread has actually narrowed, although from fairly elevated levels. We fully expect the bearish sentiment to reverse eventually given the conducive underlying backdrop as discussed above. This should bring back interest in the 15 year segment as well, especially as supply there via auctions is fairly limited (14% of first half borrowing calendar).
Thus, with a view to somewhat diversifying our portfolio performance triggers, we have used the relative movement in spreads as illustrated above to add positions in the 14 – 15 year government bonds and reduce somewhat our 30 year exposure. When combined with the existing long end bond positions, the overall dilution to portfolio duration is tolerable. The diversification also makes sense from the standpoint that one cannot be sure to what extent market feedback for reducing long end supply will actually get reflected in the second half borrowing calendar. It is possible that part of the supply gets diverted to the 10 – 15 year segment thereby setting up long bond term spreads to compress. On the other hand, should this be done only modestly then the 14 – 15 year positions should do well given the view that the dent to market sentiment is temporary and that the underlying environment remains decidedly bullish for duration bonds. Our new positioning accounts for both these eventualities. As always, this reflects our thinking as on date and we will retain flexibility in positioning depending upon evolving views.
Source: RBI and Bandhan Internal Research
Disclaimer:
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of Bandhan Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security, if any, may or may not continue to form part of the scheme’s portfolio in future. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement/document as may be required from time to time. Neither Bandhan Mutual Fund (formerly known as IDFC Mutual Fund)/ Bandhan Mutual Fund Trustee Limited (Bandhan AMC Limited), its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance may or may not be sustained in future.