How should debt fund investors invest post the RBI policy?

The Reserve Bank of India kept the key lending rate unchanged at 6.5 percent.

The Reserve Bank of India (RBI) maintained its benchmark interest rates at 6.5 percent on June 7, focusing on inflation following an unexpected election outcome. Consequently, India’s 10-Year Bond yield rose 0.06 percent to 7.02 after the policy announcement.

In the Monetary Policy review, RBI governor Shaktikanta Das retained the Consumer Price Index (CPI) forecast at 4.5 percent and upped the Gross Domestic Product (GDP) growth forecast from 7 percent to 7.2 percent. The governor referred to higher commodity prices as a key risk to the CPI inflation forecast.

Rate cuts outlook

According to experts, an interesting development in the June 7 meeting was that two external members (Dr. Ashima Goyal and Professor Jayanth R. Varma) of the Monetary Policy Committee (MPC) were in favour of a rate cut.

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“ECB (European Central Bank) has cut rates and increased inflationary outlook in a bid to reduce real rates and prop up growth impulses. In India, growth is expected to go up, and hence there is no urgency to reduce nominal or real rates. It appears that RBI will wait for inflation to sustainably come close to 4 percent before easing monetary policy. Bond yields will trade in a range of 6.90-7.10 percent for some time to come,” said Sandeep Bagla, Chief Executive Officer, Trust Mutual Fund, in a note.

Indranil Pan, Chief Economist at YES Bank, was also of the view that the RBI was unlikely to be hasty in its decision to pivot and would be guided by the domestic growth-inflation mix in determining the timing of its policy move.

“With growth expected to remain firm, the last phase of dis-inflation towards the 4 percent target remains arduous, and hence, RBI would be willing to bide its time. We see a shallow rate cut this fiscal, probably starting in December 2024,” Pan said in a note.

Impact on yields

From the markets perspective, Mahendra Kumar Jajoo, Chief Investment Officer (CIO)–Fixed Income, Mirae Asset Investment Managers, said the June 7 policy turned out to be a relative non-event. “Bond yields remained largely range-bound. The market is also focused on the contours of the new government being formed. Expect bond yields to remain range-bound with a slight easing bias for now,” he said.

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Murthy Nagarajan, Head-Fixed Income, Tata Asset Management, meanwhile, is of the opinion that 10-Year bond yields are expected to trade below the 7 percent level in the coming months.

Deepak Agrawal, CIO-Debt Kotak Mahindra AMC believes that interest rates have peaked domestically and globally.

On long-term rates, Agrawal said that apart from rate cuts, the demand/supply dynamics of the Indian bond market were very favourable.

“Lower supply of bonds, index flows, RBI commitment to 4 percent inflation, stable currency, expectation of rate cuts over the next one year, can lead to 10-Year bonds trending lower in the 6.50-6.75 percent band over the course of the next one year,” Agrawal said in a note.

How should investors invest?

Given the current fixed-income setup, Agrawal of Kotak Mahindra AMC suggests that investors with a one-year-plus investment horizon can consider investing in long-duration funds, Gilts, dynamic or three-year duration funds that have a higher allocation to corporate bonds such as medium-term funds or banking PSU funds.

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“We have been advising investors to increase the duration of their portfolio for the last six-nine months,” said Agrawal.

Sharad Chandra Shukla, Director at Mehta Equities is also of the opinion that bond investors should invest in long-term bond funds or long-term G-Sec funds.

Meanwhile, Sapna Narang, Managing Partner, Capital League, believes that following the ECB and Bank of Canada rate cuts, there is a higher possibility that the US Federal Reserve will cut rates and that the RBI will follow suit, in a short period of time.

“Long-term debt investors should lock in the present high rates in fixed deposits for a longer tenure. And in debt mutual funds, investors can add to the ‘duration’ with an 18-month view,” Narang told Moneycontrol.