DSP Converse March 2024

Our Framework

Takeaway:
Domestic environment steady, US pricing of rate cut expectations to drive bond yields

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; FPI: Foreign Portfolio Investment; NSSF: National Small Savings Fund; VRR: Variable Repo Rate; VRRR: Variable Reverse Repo Rate; o/n: Overnight

Be Long! Why?

Domestic macros supportive of lower yields

However, globally data resilient and rate cuts priced in

Let’s revisit our rates call trajectory

Source – Bloomberg, Internal

To start with,

Recap of events since last DSP CONVERSE release.

RBI Policy

US Fed removes reference to “additional policy firming” but needs “greater confidence” to cut

US Data showing resilience

RBI’s maintains status quo

• REPO rate unchanged at 6.5%

• Stance retained at “focused on withdrawal of accommodation”

  • ✓ By a majority of 5 out of 6 members

• Inflation Projections unchanged for FY24 and lower by 20bps for Q4

  • ✓ Rabi sowing has surpassed last year’s level
  • x Considerable uncertainty prevails on the food price outlook and crude oil prices, however, remain volatile
  • x Remain vigilant to ensure that we successfully navigate the last mile of disinflation as 4.0% target yet to be reached

• FY25 Real GDP projection at 7.0%. Revised up for Q1/Q2/Q3FY25

  • ✓ Sustained profitability in manufacturing and underlying resilience of services to support growth
  • ✓ Household consumption expected to improve and prospects of fixed investment remain bright
  • x Headwinds from geopolitical tensions, geo-economic fragmentation and volatile financial markets

RBI: Reserve Bank of India; GDP: Gross Domestic Product

US data shows resilience and Fed not to rush into cutting rates

Takeaway:
Fed not to rush into cutting rates

Source – Bloomberg, Federal Reserve PCE: Personal Consumption Expenditure; FOMC: Federal Open Market Committee

Now our framework

And

What we track

Our Framework

Takeaway:
Domestic environment steady, US pricing of rate cut expectations to drive bond yields

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; FPI: Foreign Portfolio Investment; NSSF: National Small Savings Fund; VRR: Variable Repo Rate; VRRR: Variable Reverse Repo Rate; o/n: Overnight

Resilient domestic economic activity

Expansion in urban demand while rural still not completely out of woods

Inflationary risks seem contained

RBI to be nimble in liquidity management

Core moderates further. Risks seem contained

Takeaway:
Domestic inflation risks seem contained. Volatility in CPI has not impacted yields (especially in 2023)

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

Domestic growth resilient so far: But watch out for trends

Takeaway:
Domestic growth seems to be resilient so far but watch out for emerging trends

Source – Bloomberg, PIB, Internal GDP: Gross Domestic Product; PMI: Purchasing Managers’ Index; GST: Goods and Service Tax; IGB: India Government Bond

What makes RBI Cut Rates?

Rate cuts: Waiting for evidence from Fed cuts

• Checklist for cut:

  • Fed Pause/Cut
  • Stable Rupee
  • CPI less than 6% (except in 2013 when RBI didn’t have 6% target)

• How is the Checklist now:

  • Fed has turned dovish, yet we await cuts
  • Given the FPI flows, forex reserves at $600bn+ and normalization of trade deficit, rupee to remain stable
  • Inflation (although expected to remain volatile), RBI to look-through one-off shocks

Source – Bloomberg FPI: Foreign Portfolio Investment; CPI: Consumer Price Inflation; Fed: Federal Reserve; RBI: Reserve Bank of India

Core moderates further

Growth remains resilient

FPI flows to support INR

After state election results, low risk in general elections

Let’s turn to Fiscal policy

Generally, it drives the long bond yields

It is reflected in demand/supply equation

Fiscal policy is favouring bonds right now

Only a small part of bond buyers are discretionary buyers

They drive yields

Supply fluctuation is borne by these buyers

Gsec market is still driven by lumpy institution purchases

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; GSec: Government Securities

Comfortable supply/demand dynamics for FY25

SDL supply only increases when states cash dip

Takeaway:
SDL supply may remain muted in FY24

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

Banks have reduced holding

Takeaway:
Bank’s demand could shift to carry assets like SDLs and Corporate Bonds with the change in HTM regulations

Source – Bloomberg, DBIE, Internal OMO – Open Market Operations, SLR – Statutory Liquidity Ratio; G-Sec – Government Securities; RBI: Reserve Bank of India; SCB: Scheduled Commercial Bank; CIC: Currency in Circulation

FPI buying to drive excess demand in FY25

• Demand to outpace supply in FY25

  • ✓ G-sec plus SDL supply is higher only by 4% over FY24
  • ✓ Global Index inclusion to support passive/active FPI buying
  • ✓ Natural demand to come from other passive buyers like Insurance, PF, NPS, etc

Takeaway:
Estimated excess demand of ₹ 0.75 lac crores.

Source – Internal, CGA 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; NSSF: National Small Savings Fund

Indian yields tracking Global yields

But with lopsided beta

Impact of US yields on Indian yields

Takeaway:
Expect correlation, but with lopsided beta

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

Money Market Assessment Framework

Takeaway:
Money market yields have rallied since the peak, driven by banking system liquidity moving into neutral zone. We remain long in our money market funds as durable liquidity is in surplus and demand supply dynamics turn favourable next quarter.

CIC: Currency in Circulation; CD: Certificate of Deposits; OMO: Open Market Operations; VRR: Variable Rate Repo; VRRR: Variable Rate Reverse Repo; RBI: Reserve Bank of India: GOI: Govt of India

Banking system liquidity in neutral zone

Takeaway:
Expect banking liquidity to move into positive zone by April

G-Sec – Government Securities; CIC: Currency in Circulation Source – Bloomberg, RBI, *Internal Estimates

Money market yields have rallied with improving liquidity position

• Durable liquidity and banking system liquidity will be in positive zone in coming weeks

• Demand supply dynamics to turn favorable next month

• Expect money market spreads over repo rate to compress in April driven by significantly improved liquidity conditions and favorable demand from MFs

Takeaway:
We continue to remain long across our money market funds

CD: Certificate of Deposits *Internal Estimates

Term premia is still not low

Takeaway:
Term premia is still attractive given favorable demand supply dynamics

Source – Bloomberg

DSP FI Framework checklist

DSP Duration decision:

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.

• Segments that has value

  • Upto 1 Yr: Tight Liquidity
  • 30 Yr: High accrual. Demand from long term investors to cap any uptick in yields

Source – Bloomberg; as on 14/Mar/24

We have discussed duration and yield movement.

How do we choose corporates and credit?

DSP Asset Allocation: Tight liquidity and supply to keep spreads high

Takeaway:
Tight liquidity and continued supply to keep spreads at elevated levels for NBFCs and AAA PSU corporate bonds are well supported at all tenors.

Source – Bloomberg, CCIL, Internal PSU: Public Sector Undertaking, NBFC: Non-Bank Financial Companies

DSP Credit Investment Process – Focus on Governance

Information sources: Financial results, Management Discussion, Rating Agency Feedback, Sell Side Research, Equity analyst feedback, Lender’s feedback, etc.

DSP Credit view on sectors

Done with our market view framework?

Now

Our Portfolio creation framework

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.

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)