Moneycontrol Pro Panorama | Fixed income’s fixations

Fund managers are recommending investors to hold on or pile up their fixed income investments as a surplus liquidity guarantee returns.

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In last Friday’s Panorama, we explained why fixed income doesn’t offer protection against wars. What it does offer is protection against every other uncertainty.

Because the bond market prices today what a debt binge would do to the economy 10 years later. This is why the all-powerful US bond market is busy fretting over the government’s fiscal deficit even though America’s tariff conflicts with the rest of the world and rising war cries across the Middle East have been far more urgent risks for equity investors.

A lot has happened since then, a reminder of the adage that sometimes decades happen in weeks. A fragile ceasefire between Israel and Iran is cooling Middle East tempers, and US President Donald Trump is back to his tariff dealmaking -- Indian officials are furiously hammering out a deal before the tariff deadline July 9 comes.

This means the spectre of the colossal debt load is back front and centre for the markets. An FT article points out that investors are dumping long-term US bond funds where the outflows have topped $11 billion in the second quarter. That is not good for the treasury market where the benchmark 10-year yield is now a massive 3.2 percentage points higher than it was in January 2021. Foreign investors and even central banks are moving away from US bonds.

America’s fixed income market is fixated with the public debt mountain that would only grow if the Senate passed Trump’s big tax bill. This debt load has repercussions for the flow and price of capital across geographies. While the US treasury market is dealing with the pain trade of a growing debt pile, it also comes alongside a growing mistrust in America’s assets and policies.

So, where is capital flowing to? Cash levels have gone up and there is no clear indication that a less trustworthy America would yield a steadiness in emerging market capital flows. For instance, India’s domestic bond market continues to see an outflow, now that the initial euphoria of inclusion in global indices has worn off.

Thankfully, our bond markets are more locally owned than dependent on foreign flows, though foreign investors do give the much-needed liquidity to local bonds. Currently, the holdings of foreign investors are not more than 5 percent of the outstanding bond pile issued by the government. Therefore, our bond markets are fixated more on domestic monetary policy and liquidity.

These two variables indicate that good times for the bond market may last longer. The Reserve Bank of India (RBI) has indicated its commitment to keep liquidity in abundance to facilitate transmission of policy rate cuts onto market interest rates, specifically lending rates. Since the central bank wants the price of capital to go down, the first rate to ease is always the low-risk sovereign. The 10-year benchmark government bond yield has inched up recently after the central bank’s policy indicated there isn’t much room for cutting rates further. Even so, the bond yield is 70 basis points lower than it was a year ago.

The odds of bond yields climbing are low given the liquidity but even if they do, the movement may not be significant enough to worry. Mutual fund managers expect the 10-year government bond yield to trade in the 6.20-6.50 percent band for the year. Fund managers are recommending investors to hold on or pile up their fixed income investments as a surplus liquidity guarantee returns. The head of fixed income at UTI Mutual Fund, Anurag Mittal, in his column for us here, explains why investors should look for medium term benefits. “The 2-4 years segment can offer stable accrual, reasonable spreads and upside optionality should the global macro-outlook deteriorate and revive expectations of further rate cuts,” he writes.
Corporate bonds are giving salivating spreads over government bonds now, enough to attract investors. The fact that April saw three times the bond issuances this year than last year is evidence enough that investors are warming up to corporate bonds in a big way. The price of debt capital will come down for Indian borrowers as banks cut lending rates and bond yields cool due to liquidity. But the benefits risk being small and restricted to only fixed income until the uncertainties that America has infused into global markets abate.

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Aparna Iyer
Moneycontrol Pro