In an interaction with Sabyasachi Mukherjee of IIFL Wealth & Asset Management, Puneet Pal remarked, “We expect comfortable banking system liquidity to be the constant factor in the near term, and hence we would be bullish in the shorter end of the curve. The longer end of the yield curve can be volatile given global headwinds.”
Excerpts of the conversation...
What's your view on fixed income market in India? How do you foresee the yields moving in near to mid-term and why?
The fixed income market in India fetched a very good return over the last 3 years, generating returns to the tune of 10‐11%. Looking forward, debt market is likely to continue to do well though not at the same level as before. The macro‐economic variables continue to be stable. RBI has reinforced the credibility of its inflation targeting objective by not cutting policy rates contrary to market expectations. INR has been stable and real yields in India continue to be relatively high. We expect comfortable banking system liquidity to be the constant factor in near term and this would support the shorter end of the yield curve up to 3 years; while the longer end of the yield curve can be volatile given global headwinds. We expect the 10‐year benchmark to remain range bound between 6.50‐7.00% in the near term i.e. for the next 3 months. Over the course of the year, we expect a 25bps rate cut by RBI.
With expectation of rising inflation across the globe and yields inching higher, what is your expectation of the global fixed income market?
Inflation has only been rising in certain developed countries like the US, however, other parts of the world like Eurozone are still falling short of the central bank’s target, while Japan is still struggling with a deflationary scenario. Thus, we would attribute the rising yields to the expectation of the higher US inflation. The global bond yields are also moving higher because of the expectations of the FED rate hikes and a possible unwinding of ECB’s expansionary policies. We expect global bond yields to be volatile in near term till clarity emerges on the US trade and fiscal policies as also on political outcomes in Europe. However, if US administration falls short of the high expectations, we expect the global bond yields to stabilize 15‐25bps below the current levels.
Is it the right time to move away from duration funds and shift to accrual funds?
As mentioned earlier, we are bullish in the shorter end of the curve i.e. up to 3 years. The RBI in its latest monetary policy has shifted its monetary policy stance from accommodative to neutral but maintained the stance on providing liquidity to the banking system liquidity going forward. This is a positive for the shorter end of the curve. Thus, investors may move from duration funds to short term accrual funds of high credit quality.
What’s your take on inflation? Do you expect any rate cuts by RBI in coming quarter?
We expect the inflation to average 4.60‐4.70% in FY 2018. This will be a bit higher than the RBI’s medium term target of 4% CPI inflation. We base our view of contained food inflation owing to higher acreage and better monsoons last year. We also expect that crude oil should trade in the range of 50-60 $ per barrel as increase in Shale oil productions should offset the OPEC production cuts. The negative impact on the consumption due to slow re‐monetization of currency notes will also help keep inflation lower. We continue to expect a 25bps rate cut in Q4 of CY2017 in order to support growth and in light of stable macro‐economic variables.
What will be the effect of Government’s borrowing program budgetary announcements on the fixed income market?
The union budget 2017‐2018 has deviated marginally from the FRBM target of 3.00% by chasing a 3.20% fiscal deficit. The net borrowing of the central government remains same as last year, post the adjustment of the buyback of 75,000 crore securities in FY 2018. We do not expect a negative fallout of the borrowing numbers though the supply of State Development Bonds (SDL) will be higher than the Central Government’s borrowing, which can lead to a wider spread between Gsec and SDLs. At the current yield of 6.85% on the 10yr benchmark, we think it is fairly priced at a spread of 60bps from the overnight rate, given that liquidity is quite comfortable.
Do you see domestic investors shifting towards equities? What strategy do you suggest for the investors?
The risks associated with an equity investment and fixed income investment are very different. Out of the total investible surplus, we believe there’s room for each asset class in line with the investor’s financial priorities and risk‐adjusted RoC expectation. For the fixed income asset allocation of the portfolio, investors may opt for short term duration funds of high credit quality.
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