Fixed income investments: Stay with short end of the curve and avoid long duration products

The yields at the short end, as well as the long end, remained more or less stable in the last two months, but the short end rates have moved up a bit in the last two weeks. The change over to normal liquidity management by the RBI has caused some consternation among the market participants. But there is nothing fundamentally different in the approach of the central bank as of now.

The market has been well supported by the surplus liquidity conditions all this while, and this may continue to be the singular factor deciding the course of the markets in the foreseeable future too. While the long end of the curve especially the 10-year benchmark has remained within a narrow range for the most part of this year between 5.80 percent and 6.20 percent, and around 5.90 percent for the most part of the recent past, over the last one year, significant fall in the rates happened at the short end of the curve if you take a closer look at the one-year CD and CP rates. This is the product of the easy money policy of the central bank and the liquidity injection that has been happening through the targeted repo operations.

The accommodative policy of the RBI is likely to continue till growth becomes more or less sustainable, and near-normalcy returns with a rebound in economic activity. But there are a couple of factors that should be kept in mind while taking a view of the rates. First of all, the rate of inflation indicated by the consumer price index still continues to be high, though at present it is lower than the threshold set by the RBI, as evidenced by the latest CPI.

Inflation from food component seems to have abated for the time being. Any persistent rise in price level may compel the RBI to moderate the liquidity support over time. Brent has been rising recently, and it is perched above the $55 a barrel level, and this upward trend in oil prices may remain intact in the immediate term and this could further fuel inflation across segments. Therefore, threats on account of rising price level remain elevated compared to any time in the recent past. These factors could trigger some pressure on yields.