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Debt mutual funds turn cautious, increase cash positions: Here’s why

Fund managers say that the uncertainty in debt markets has increased due to inflationary pressures

December 07, 2021 / 10:18 AM IST

Debt mutual fund managers are in wait-and-watch mode and holding onto cash in their schemes. They are concerned over a potential rise in bond yields in the short as well as longer-end of the yield curve.

“Earlier, the shorter-end of the yield curve gave a source of comfort amid concerns of interest rate hike, but with Reserve Bank of India (RBI) now reducing liquidity through Variable Reverse Repo Rate (VRRR) auctions, the yields in the shorter-end of the curve are also starting to rise,” says Marzban Irani, chief investment officer-fixed income, LIC MF.

“The reverse repo rate has effectively increased due to VRRR. But when the RBI actually raises the reverse repo rate, short-end yields could go up further,” he adds.

The reverse repo rate is the rate at which RBI borrows from banks. In August 2021, the RBI launched enhanced VRRR auctions (every fortnight) to drain excess liquidity from the banking system. In October 2021, it suspended the G-SAP (Government Securities Acquisition Program), which was used to infuse liquidity in the debt markets via the purchase of G-Secs.

Uncertainty in debt markets

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Fund managers also say that the uncertainty in debt markets has increased due to inflationary pressures and the likelihood of unwinding of US Fed’s stimulus measures.

“We have further increased cash levels in our actively managed bond and gilt funds to approximately 60-70 percent as at November 23, 2021,” Suyash Choudhary, head-fixed income of IDFC MF, pointed out in a recent note.

While the fund house will continue to review its cash positions and keep making changes as and when necessary, Choudhary says the uncertainty still persists.

“The US Fed is a major variable and right now there seems to be a wide gap between inflation expectation in US and current state of US Fed policy. One-and-a-half months back, RBI said that it expected food inflation to continue falling, but food prices have rebounded sharply. Tariff hikes also happened recently, which will add another 10-15 basis points to inflation estimates,” Choudhary says.

“The growth recovery in India has also been much better than in other economies. The worry over the Omicron variant has cropped up recently, which needs to be monitored closely,” he adds.

The rising price of commodities as well as oil has contributed to inflationary pressures. On December 2, 2021, contrary to fears, the Organisation of Petroleum Exporting Countries (OPEC) decided against cutting back its supply. However, the OPEC may decide reduce its output, which may push up oil prices further.

In current calendar year, Brent Crude oil prices have already surged 28 percent to $71 per barrel.

Budget and fiscal deficit

Apart from inflation and US rate tightening, fund managers also think Union Budget 2022-2023 could influence debt markets.

“We need to see if the Budget will be expansionary, as several state elections are also going to be held next year. An expansionary Budget would mean more supply of G-Secs for government borrowing, which may put upward pressure on bond yields,” says Sandeep Yadav, head-fixed income, DSP MF.
Jash Kriplani is a journalist with over ten years of experience. Based in Mumbai. Covering mutual funds, personal finance. His last stint was with Business Standard, where he covered mutual funds and other developments in the financial markets
first published: Dec 7, 2021 10:18 am

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