Dhawal Dalal, CIO (fixed income), Edelweiss Asset Management, tells Tushar Goenka that he expects the 10-year government bond yields to trade around 8-8.25% levels in the near term. Excerpts:
What is the way forward with the yield? Where do you see the benchmark yield heading?
The trajectory of the Indian government bond yields will likely depend on US treasury yields, the rupee’s exchange rate, movement in the crude oil prices and likely slippage in fiscal deficit in FY19. Yields of 10Y UST has been in a tight range of 2.80-3% despite robust economic growth and hints for further rate hikes by the FOMC going forward. We believe that further rate hikes will likely push the 10Y UST towards the 3.2-3.3% levels in the first quarter of CY2019. We believe that Indian 10Y government bond yields should trade at around 5% spread to the 10Y UST.
Current volatility in the rupee, hardening of the crude oil prices and resultant increase in current account deficit may dampen sentiment despite attractive current levels.
That said, bond market participants also expect the Reserve Bank of India to infuse permanent liquidity in the banking system through government bond purchases from the secondary market in the second half of the year. That should improve sentiment and anchor government bond yields. Therefore, we expect the Indian 10Y government bond yields to trade around 8-8.25% levels in the near-term.
What is the single biggest problem in the debt market at the moment?
Lack of appetite is the single biggest issue in the bond market at the moment. There has been a perceptible decline in daily trading volume in government bonds. Foreign portfolio investors are net sellers in Indian government bonds. Mutual funds are facing net outflows from duration funds.
All these factors are contributing to demand-supply imbalances in the bond market and causing long-only investors some unease in committing fresh capital to debt capital markets.
Given the recent increase in yields of AAA-rated PSU bonds since September 2017, we believe there is value in these assets maturing in the 2-3Y segment compared to what is available in traditional instruments. We recommend investors with investment horizon of at least three years to start investing in a staggered manner to benefit from the recent increase in high-quality bond yields.
The net issuances of corporate bonds has declined in the quarter ended June 2018. What drove this decline? Is this a sign of worry?
The first quarter of FY19 witnessed significant increase in volatility in bond yields with both government bonds as well as corporate bond yields hardening due to multiple factors. As a result, there was a net outflow of investors from duration funds and net inflow in liquid funds due to superior risk-adjusted returns and higher liquidity.
As a result, we have a seen a decline in issuance of corporate bonds maturing in the 2-3Y segment due to lack of appetite among investors.
Further, steady outflows from duration funds have resulted in hardening on bond yields in the secondary market. It caused a significant mis-match in expectations of yields between primary issuers and investors as issuers were not ready to match elevated yields expectations of investors. As a result, many issuers decided to adopt a wait-and-watch approach. Some of the borrowers also tapped bank loans for funds as they were relatively cheaper compared to the bond market.
Retail inflation stood at 4.17%, much lower than the projections. How much of this will affect the RBI’s decision on October 1?
We believe that recent increases in the repo rates by the MPC were “pre-emptive” in nature given the recent increase in FX volatility and building up of imbalances in the economy despite softer headline inflation.
We also believe that widening of trade deficit is symptomatic of these imbalances in the economy, which may warrant a monetary as well as fiscal response in the near-term.
Based on that, we believe that the odds for further increase in the repo rate are increasing in the October review, given the recent movement in the rupee against some of its peers as well as further hardening in crude oil prices could negatively impact input costs and headline inflation in the medium term.