Indian bond yields continued their bearish upward trend in October. The 10-year government bond yield rose by 20 basis points (bps) to end the month at 6.86%. Bond yields have now inched up by more than 40 bps since the August monetary policy where in it had bottomed at 6.4%. A combination of hawkish RBI statements, rise in US treasury yields, general increase in price of oil and other global commodities and worries on the fiscal deficit has led to this increase in market interest rates. The rise in October also started with the RBI policy being perceived more hawkish than warranted. The RBI commentary though was tilted more towards the risks of inflation going above the 4% headline CPI target. The markets have now given up expectations of rate cuts.
Fiscal deficit
The other major reason for the bearishness has been the dilly-dallying by the government on meeting the fiscal deficit target for this fiscal year ending March 18. Lower growth numbers were interpreted to convey that the government will announce a fiscal stimulus. The government announced a bank recapitalisation plan to infuse equity capital of Rs 2.11 lakh crore into public sector banks; out of which Rs 76,000 crore will be in the form of direct budgetary support from government and capital rising by banks in market and the rest Rs 1.35 lakh crore will be through bank recapitalisation bonds. The market will look out for details about the structure of these bonds and guidance on government’s fiscal plans.
On the global front, European Central Bank had acknowledged ongoing improvement in economic activity and announced plan to reduce its monthly asset purchases from EUR 60 billion to EUR 30 billion starting January 2018. The US treasury yields have also risen meaningfully due to renewed expectation of tax reforms and improved economic data. We expect that the developed markets’ central banks will continue to follow the gradual tightening of monetary conditions.
Outlook
At the current levels with most of the bond yield curve closer to 7%, we believe that most of the adverse news impact on markets would be negligible as markets have considered them already, levels remain attractive. If the government increases the fiscal deficit target next year then we would expect further increase in bond yields. Else, based on our expectation of muted inflation but no rate cut expectations, we expect bond yields in 6.65%- 6.90% level.
–Pankaj Pathak
The writer is fund manager, fixed income, Quantum Mutual Fund