Monetary policy Committee (MPC) of Reserve Bank of India (RBI) has announced a 50-basis-point hike in repo rates. By the time the Governor Shaktikanta Das completed his address on August 5, the 10-year benchmark bond yield jumped to 7.25 percent compared to 7.15 percent on the previous day. Though there was an expectation that the RBI will continue to increase the repo rate, the quantum of rate hike was heavily debated by the economists and markets participants. On this background, let’s see how the fixed income investors should realign their investments.
What to expect going forward?
The MPC has brought the repo rate at 5.4 percent with immediate effect after the 50 basis points hike announced today. After accounting for 90 basis points hike earlier this year, the increase in repo rate stands at 140 basis points. The increase is aimed at controlling inflation.
The market participants expect the inflation cool down as the inputs costs to go down with fall in prices of metals, energy and agri commodities. The fears of recession may act on the inflation control targets of central bankers worldwide and central bankers may go slow on rate hike cycle.
In India the inflation has come down to 7 percent compared to 7.8 percent in April. The MPC has moreover maintained the inflation estimates it gave in the previous monetary policy. “On the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, the inflation projection is retained at 6.7 per cent in 2022-23, with Q2 at 7.1 per cent; Q3 at 6.4 per cent; and Q4 at 5.8 per cent, and risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 per cent,” reads the monetary policy statement.
If the key input prices such as crude oil continue to trend down then there is a possibility that RBI may go slow on the rate hike cycle. “Brent crude and other commodities prices are easing and likely to ease further on recession fear in U.S. and European countries. This will benefit India as we are importing around 80% and will relieve the pressure on the fiscal of the government. Lower inflation will ease out the pressure and post second quarter, we can expect RBI to be soft on the interest rates, says Deepak Panjwani- Head Debt Markets, GEPL Capital. He expects another 50 basis points hike in two tranches of 25 basis points each.
That is a clear warning sign for most fixed income investors who were keen to lock in their money in long term bonds. The 10 year benchmark bond yield moved to 7.6 percent earlier this year before cooling off taking cues from the global market. Some savvy investors also entered long term gilt funds in May 2022.
However, the experts warn retail investors against such adventures. “Do not jump into long term bonds or long duration debt funds assuming the rate hike cycle has ended. Expect a 25 to 35 basis points hike in forthcoming policy. We may see more rate hikes in future,” says Vikram Dalal, Founder and Managing Director, Synergee Capital Services.
If the yields on long duration bonds move up, then there will be marked to market losses on these bonds as well as on debt fund schemes investing in them. Panjwani expects the 10-year benchmark to move in the range of 7 percent to 7.8 percent till March 2023.
What should you do?
You should avoid taking any extreme view on your fixed income portfolio. Do not keep all your money in liquid funds assuming the rates are going to go up forever and also do not put all your money in long duration debt funds assuming the rate hikes are almost over as the USA and other developed nations may stop their rate hikes fearing recession.
Dalal advocates building a ladder of debt investments. “Bond investors should ideally take exposure to bonds maturing in two, five, seven and ten years. Conservative investors in debt funds are better off with suitable Bharat Bond ETF Series and banking & PSU Debt funds," he says.
If you are investing in a target maturity debt funds including Bharat Bond ETF ensure that you hold them till maturity. If the yields go up in the interim period then you may see the pressure on net asset value (NAV) of the scheme and holding them till maturity will ensure that the you take home expected returns (yield to maturity minus the expenses) at the time of entry.
Short duration funds with two to three years duration also make good investment candidates.
Abhay Mathure, a Mumbai based Mutual Fund distributor expects the rate hike cycle to continue. He advocates investments in dynamic bond funds for investors with more than three year time frame. Dynamic bond funds let the fund manager take a view on the expected interest rate movements and accordingly build the portfolios. These schemes can help investors benefit from excess returns generated by the fund manager by taking advantage of changes in interest rates and mispriced opportunities in bond market.
“Investors in low income tax slabs with short term view can look at select corporate fixed deposits to benefit from the rising interest rates,” he adds.Rising interest rates tend to pressurize low rated corporates with leveraged balance sheets and some of them may find it difficult to refinance debt. Avoid chasing high yield bonds as in most cases, they carry high credit risk.