The yield on longer-tenure government securities (G-Secs) is expected to rise marginally in the coming months on expectation of less aggressive rate hikes by central banks at their coming policy meetings due to lower growth and recession fears, money market dealers said.
So far in this month, yields on G-Secs, especially the 10-year benchmark bonds, remained range-bound and moved in the narrow band of 7.46-7.51 percent. “It is due to some value buying from investors,” a dealer said.
Long-term rates remained stable with a dovish bias as growth is a constant worry. However, short-term debt instruments’ yields have risen sharply during this period.
“The rates in long tenors will go up but the quantum is likely to be very limited. As growth suffers and the recessionary environment takes its toll, regulators are likely to be much less aggressive in their rate hikes,” said Ajay Manglunia, managing director and head of Investment Grade Group at JM Financial.
Recession fear
Investors in India and elsewhere are very concerned about the recession fear which is prevalent right now. Some fund managers also said that as most central banks have aggressively raised interest rates to tame inflation, emerging markets may face a financial crisis in the coming months.
Investors are also concerned about the Russia-Ukraine war and higher inflation figures in most of the advanced economies.
Due to this, the International Monetary Fund (IMF) earlier this month said that economies around the world will experience a slowdown next year.
But the Indian finance ministry in its monthly economic review for September said the country’s growth and stability concerns are less than that of the world at large and estimated the country’s medium-term growth rate above 6 percent.
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Short-term yields
So far in October, yields on short-term debt instruments have risen sharply by more than 50 basis points across instruments on the Reserve Bank of India (RBI) raising its policy rate and due to lower liquidity in the banking system.
Usually, whenever the liquidity in the banking system dries up, investors start demanding higher rates on their investment.
“Besides the rate hikes, the current liquidity in the banking system is not adequate and hence investors prefer higher yield on their investments,” said Venkatakrishnan Srinivasan, founder and managing partner at debt advisory firm Rockfort Fincap.
Yields on commercial papers and certificates of deposits have risen by 80 basis points and on Treasury bills by 30-35 basis points since the start of this month.
The yield on certificates of deposits maturing in three months are trading near 10-year G-Sec levels as most banks have started tapping the market to raise funds due to lower liquidity and a sharp rise in credit offtake due to the festival season demand.
“The liquidity crunch is ensuring a spike in short-tenor rates further aided by aggressive rate actions by regulators across the world. After a long time, we see banks accessing the CD market in the face of strong credit offtake and a decline in systemic liquidity,” Manglunia added.
The banking system has been facing a liquidity crunch over the last few weeks due to heavy currency outflow on account of festive season and regular intervention by the RBI in the foreign exchange market to keep the rupee from falling sharply.
Usually, in the second half of the financial year, currency leakage increases sharply as spending goes up on account of the festival season.
Currently, liquidity in the banking system is estimated to be in deficit of around Rs 73,296.89 crore, according to dealer at a large state-owned bank.
Also read: Higher revenue receipts help Odisha avoid market borrowing
Shift in investment
Money market dealers expect investors to shift their investment in short-term debt to medium-term papers due to a large supply of short-term bonds combined with rate hikes, which will increase their returns on investment.
However, some fund managers believe investors may build their positions cautiously going forward considering domestic and global cues.
“Long-term investors like EPFO (Employees’ Provident Fund Organisation) and LIC (Life Insurance Corporation of India) always prefer long-term bonds and that’s the reason we have seen corporate bond levels go below G-Sec sometimes. In case of short supply of long-term bonds, large investors may shift to three-year and above tenor instruments,” Srinivasan added.
“Considering the duration-accrual balance, the three- to five-year segment remains the best play as core portfolio allocation,” said Pankaj Pathak, fund manager, fixed income, Quantum Mutual Fund, in a report of Debt Monthly Observer for October 2022.
Medium- to long-term interest rates in the bond markets are already at long-term averages compared to fixed deposits which remain low. With higher accrual yield (interest income) and relatively lower price risk (compared to the last two years), dynamic bond funds are appropriately positioned to gain over the next two to three years, Pathak added.
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