The bond market has been relatively buoyant the past few days, despite not-so-encouraging macro fundamentals and weak global cues. Shobhit Mehrothra, head of fixed income at HDFC MF, explains that this is because the bond market is pinning its hopes on the start of the fiscal consolidation process by the government.
“We have all been waiting for the Presidential elections to get over and the process of fiscal consolidation to begin with a fuel price hike, diesel price hike and that in turn would lead to 2% subsidy cap which the Finance Minister had mentioned in the Budget that they would endeavor to meet,” he said in an interview to CNBC-TV18.
However, the lack of actual policy measures still casts a shadow over the market. Especially with crude prices rising again, if the government does not act on a diesel prices or fuel prices, and if the Reserve Bank keeps interest rates unchanged, Mehrotra says bonds could see a sell-off. “We could see yields rising by 10-15 bps, that’s a distinct possibility,” he said.
From a one year time frame, Mehrotra sees the 10 year bond range around 8-8.25%. However, he says that this is dependent on inflation and steps taken for fiscal consolidation.
Below is an edited transcript of his interview with Lathe Venkatesh and Ekta Batra.
Q: What exactly is the bond market or the 10 year factoring in at 8.07%?
A: One major factor which the bond market is right now looking at is the beginning of the process of fiscal consolidation. We have all been waiting for the Presidential elections to get over and the process of fiscal consolidation to begin with a fuel price hike, diesel price hike. That would in turn lead to 2% subsidy cap which the Finance Minister had mentioned in the Budget that they would endeavor to meet. So the process of fiscal consolidation beginning in earnest is what the bond market is been pinning its hopes on.
Q: If we don’t get to hear anything on fuel hike anytime soon, will the market perhaps give way very badly? What kind of a time leeway will the bond markets give the government?
A: May be 1-2 weeks, may be till the credit policy. Till 31st July we should see some measures being announced. I think that’s what market has been hoping for. Now if they don’t come in and if we don’t get any rate action on 31st July, yes there could be sell off. We could see yields rising by 10-15 bps, that’s a distinct possibility.
Q: Where exactly does the liquidity deficit currently stand at and if it is reduced from that Rs 90,000 – 1 lakh crore that we were seeing on an average earlier for a few months, what do you think is a sustainable level for it?
A: Liquidity has become within the comfort zone of RBI of 1% of NDTL and the open market operations (OMOs) which RBI has conducted have contributed to the liquidity situation improving. At the moment we feel that this kind of liquidity would continue for sometime and only perhaps in the later part of the year is when we may need some liquidity easing measures from RBI through either a CRR cut or more of OMOs. But the sense is that RBI is going to be far more proactive in terms of providing liquidity to the market than what we have seen in the past.
Q: So what is the range you are giving for the 10 year given the kind of political possibilities and which fixed income product are you telling your investors to move into?
A: In terms of product recommendations, we have been very positive on the short-term bond category for quite some time. Based on a risk adjusted basis, short-term bond funds continue to look quite attractive.
In terms of longer duration products, yes one has to have a long term horizon. You need to have at least one year view to get into long duration bond funds. On the 10 year range, what we are looking at is may be 8-8.25%. A lot would depend on how the inflation trajectory pans out and what happens on the fiscal steps. So if indeed reform measures on subsidy are announced and fiscal situation is brought within what the budget has targeted, then we could be on the lower end of the range.
Q: But for six months and one year investors, what are you selling as a fund house? Would you sell fixed income over equities?
A: We always recommend the product category allocations, so one needs to be well diversified.