Neutral is the word

Our View – Summary

Our Strategy: Be invested – neither underweight, nor overweight

10Y Indian Gsecs have rallied 50 bps to 7%. For a further rally markets need to “price in” future rate cuts. But the US labor, CPI and services data have remained robust. Unless US (or India) economic data softens, rate cuts won’t be expected. Until then yields won’t fall.

In such a scenario, currently we prefer being neutral. If underlying macro data does not change, but markets rally on sentiment – we will sell and go underweight. If markets sell on panic, we will buy .

But if the macro data weakens, we will add duration without hesitation

For money markets investment: Even though the yields have rallied, we believe, staying in the longer end of the money markets curve is more beneficial. The surplus liquidity will keep a cap on rates.

• Reasons for our view

  1. Data just isn’t weakening: The US data remains sticky. Indian inflation has softened- but this seems transient. Thus, why should central banks cut rates? But markets have priced in rate cuts.
  2. Demand-Supply has turned neutral: Banks SLR holding has increased to high levels. But the demonetization may lead to more purchases. The Insurance/PF/EPFO will continue to buy. But SDL issuances may increase

• Risks to our view

  1. Date dependency: Continued strong job market could be inflationary, and similarly a weaker data will mean crash of yields. India data too is unsure, with El Nino/monsoon, Crude prices.

G-Sec: Government Securities; SDL: State Development Loans; CPI: Consumer Price Inflation; PF: Pension Funds; EPFO: Employees’ Provident Fund Organization; SLR: Statutory Liquidity Ratio

Let’s revisit our rates call trajectory

Source – Bloomberg

RBI continued with a PAUSE

• Rate Action

  Unanimously voted to keep key policy rates unchanged at 6.5%

• Stance

  5 of 6 members voted for remain focused on withdrawal of accommodation

• Inflation

  Revised lower by 10bps to 5.1% for FY24

  • ✓ Revised down sharply for Q1 from 5.1% to 4.6%
  • ✓ Forecast of a normal south-west monsoon augurs well for kharif crops
  • X Outlook on crude prices remain uncertain

• Growth

  GDP forecast retained at 6.5% for FY24

  • ✓ Good rabi crop, expected normal monsoon & buoyancy in services to support demand
  • X Weak external demand and geo-political tensions remain a concern

RBI: Reserve Bank of India

FED did a hawkish PAUSE

• Rate Action

  • Unanimously voted to keep key policy rates unchanged

• Future course

  • Average dot plots (expected fed rates) imply two more rate hikes
  • This was the expected peak rates before banking crisis

• No FOMC member expects rate cuts in 2024

Source – Bloomberg FOMC: Federal Open Market Committee

US Bank crisis waning – upside risks to rates

Source – Bloomberg FOMC: Federal Open Market Committee; B/S: Balance Sheet; Fed: Federal Reserve

US Data still not showing any conclusive signs of weakness

Source – Bloomberg NFP: Non Farm Payroll, PMI: Purchasing Managers’ Index

Our Framework

Takeaway:
We are neutral on all parameters. We wait for weaker data to change our view

CAD – Current Account Deficit; BoP – Balance of Payment; SLR – Statutory Liquidity Ratio; SDL – State Development Loans; RBI: Reserve Bank of India; G-Sec: Government Securities; OMO: Open Market Operation; FPI: Foreign Portfolio Investment; B/S: Balance Sheet; FOMC: Federal Open Market Committee; CRR: Cash Reserve Ratio; PMI: Purchasing Managers’ Index; GST: Goods and Services Tax

Inflation cools off, but set to rise

Takeaway:
Best in CPI probably behind – set to rise up. Rules out any rate cuts for now.

Source – Bloomberg, RBI, Internal CPI: Consumer Price Inflation; RBI: Reserve Bank of India; IGB: India Government Bond

Inflation to remain above RBI’s comfort zone

Takeaway:
Even if lower CPI surprises, it will still remain above Governor’s comfort zone.

Source – Bloomberg, PIB, Internal CPI: Consumer Price Inflation; RBI: Reserve Bank of India; MSP: Minimum Support Price

Will global slowdown test domestic growth?

Takeaway:
Domestic growth seems resilient so far despite global slowdown fears

Source – Bloomberg GDP: Gross Domestic Product; PMI: Purchasing Managers’ Index; GST: Goods and Service Tax; IGB: India Government Bond; Mfg: Manufacturing; MSME – Micro, Small & Medium Enterprises

What drives pauses: Series of hygiene factors

Takeaway:
RBI delivered a pause in Jun 23 MPC, but higher than expected FOMC rate hikes to remain concern

Source – Bloomberg RBI: Reserve Bank of India; US FED: US Federal Reserve; BoP – Balance of Payment; CPI: Consumer Price Inflation: MPC: Monetary Policy Committee

RBI actions followed FOMC – expect the same going ahead

Takeaway:
RBI MPC has shades from FED FOMC. If Fed hikes a lot, don’t be surprised with RBI

Source – Bloomberg, Federal Reserve RBI: Reserve Bank of India; US FED: US Federal Reserve; FOMC: Federal Open Market Committee; MPC: Monetary Policy Committee

Why should RBI follow FOMC?

• RBI tracks FOMC because of emanating rupee risks…

• ..But rupee is stable, so why should RBI worry about FOMC?

• Because no one knows how rupee will react if FED rates go ~6%

  • Higher FED rates could lead to recession in US impacting
    • Software and merchandise exports
  • There could be risk-off and capital outflows from emerging countries

• Bottom-line: We are wary of risks. We don’t know how, or even if they will pan out.

FOMC: Federal Open Market Committee

Gsec market still driven by lumpy institutions

Takeaway:
Increase in supply impacts the discretionary buying. Banks excess holding, passive buyers have been absorbing the supply

Source – DBIE LCR – Liquidity Coverage Ratio; SDL – State Development Loans; PF – Provident Funds; PD – Primary Dealerships; MF – Mutual Funds; FPI – Foreign Portfolio Investors; FI – Financial Institutions; RBI: Reserve Bank of India; G-Sec: Government Securities

SDL supply picks ups… will it impact yields

Takeaway:
SDL supply picking up with drop in cash balance, albeit may remain muted in FY24

Source – DBIE, RBI T-bill: Treasury Bill; SDL: State Development Loans; GSDP: Gross State Domestic Product

Banks have already bought a significantly!

Takeaway:
Banks’ probably lesser demand in future to be negative.

Source – Bloomberg, DBIE, Internal OMO – Open Market Operations, SLR – Statutory Liquidity Ratio; G-Sec – Government Securities; RBI: Reserve Bank of India; FRA: Forward Rate Agreement; TRS: Total Return Swap

Large liquidity infusion delays OMO or CRR

Takeaway:
Chances of OMO or CRR pushed back to at least Q3, probably Q4

Source – Bloomberg, Internal OMO – Open Market Operations; CRR: Cash Reserve Ratio; CIC: Currency in Circulation; RBI: Reserve Bank of India

How much is the excess supply

• Excess supply can be matched by

  • ✓ G-sec supply higher only by 7% over FY23, however demand is expected to rise much more
  • ✓ Continuing strong demand from long end investors like EPFO, Insurance and PFs

Takeaway:
Estimated excess supply of INR 1.06 tn not very significant. NPS may grow at 20% (we have taken 13%), Banks may sustain current SLR ratio of 30.5% (we have taken 30%)

Source – Internal G-Sec: Government Securities; OMO: Open Market Operation; RBI: Reserve Bank of India; FPI: Foreign Portfolio Investment; NPS: National Pension System; MF: Mutual Fund; SDL: State Development Loans; SLR: Statutory Liquidity Ratio; PF: Provident Fund; EPFO: Employees’ Provident Fund Organisation

Indian yields – Dancing on its own chords

Takeaway:
India bond yields more driven by domestic factors.

Source – Bloomberg, Internal Fed: Federal Reserve; CPI: Consumer Price Inflation; RBI: Reserve Bank of India; IGB: India Government Bond; FOMC: Federal Open Market Committee; UST: US Treasury

Supply-demand to be the key driver for short end yields

• Divergence between credit and deposit growth continues
• Increased issuances both CD and CP
• With higher maturities lined up in June, expect supply to remain high
• High T-bill supply kept the short end yields elevated; however with liquidity easing short end rates have come off

Source – Bloomberg, Internal CD: Certificate of Deposits; CP: Commercial Paper; T-bill: Treasury Bill

Term premia: Data dependent

• If there is an extended pause (likely scenario)

  • Premia is on a lower side… One may see volatility at these levels.

• But if there is even one more hike (low probability)

  • Premia should rise significantly – touching March levels

• If there is short pause, followed by cut (low probability)

  • In 2014/2018, the term premia reduced
  • Both these instances led to rally in duration yields

Takeaway:
Term Premia has been low historically in years of pause

Source – Bloomberg

DSP FI Framework checklist : What is our view on yields movement?

DSP Duration decision: How much of yield movement is priced in?

The chart shows how much expected yield fall/rise is already priced in the current curve.

Large gap between the current yield and forward yield shows that yield change is priced in – and thus yield change will not give capital gain/loss.

Similarly small gap means that the market is not pricing change in yields.

• Market expects yield curve to remain flat

  • The future rate curve is close to current yield curve, expecting yields to remain range bound

Source – Bloomberg; as on 6/Jun/23

DSP Portfolio Creation: Multi-step process

DSP Fixed Income Funds follow a defined methodology for fund portfolio construction

• We apply market risk filter which can help the Fund Managers not to take extreme risks. Thus, Value at Risk is limited by ensuring the positions are balanced.

Investment approach / framework/ strategy mentioned herein is currently followed & same may change in future depending on market conditions & other factors.

DSP Credit Investment Process – Better Safe, than Sorry!

DSP Asset Allocation: Corporate bonds vs. Sovereign Bonds

Takeaway:
Corporate bond spreads near their long term average, spread curve flat.

Source – Bloomberg, CCIL

Key Risks associated with investing in Fixed Income Schemes

Interest Rate Risk - When interest rates rise, bond prices fall, meaning the bonds you hold lose value. Interest rate movements are the major cause of price volatility in bond markets.

Credit risk - If you invest in corporate bonds, you take on credit risk in addition to interest rate risk. Credit risk is the possibility that an issuer could default on its debt obligation. If this happens, the investor may not receive the full value of their principal investment.

Market Liquidity risk - - Liquidity risk is the chance that an investor might want to sell a fixed income asset, but they’re unable to find a buyer.

Re-investment Risk - If the bonds are callable, the bond issuer reserves the right to “call” the bond before maturity and pay off the debt. That can lead to reinvestment risk especially in a falling interest rate scenario.

Rating Migration Risk - - If the credit rating agencies lower their ratings on a bond, the price of those bonds will fall.

Other Risks
Risk associated with

• floating rate securities
• derivatives
• transaction in units through stock exchange Mechanism
• investments in Securitized Assets
• Overseas Investments
• Real Estate Investment Trust (REIT) and Infrastructure Investment Trust (InvIT)
• investments in repo of corporate debt securities
• Imperfect Hedging using Interest Rate Futures
• investments in Perpetual Debt Instrument (PDI)