Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Inflation concerns, Hawkish Pivot and rising case of hard landing
February 2023 turned out to be extremely volatile month. Starting the month on
positive note –from resilient growth, improving external balance & internal balances
to rising case of soft-landing and policy rate near peaking (global and in India), the
month saw change in narrative to more hikes along with higher for longer pivot,
stubborn inflation and strong economic growth.
Monetary Policy:
In Feb-23 policy, RBI hiked the key policy rate by 25 bps to 6.5% - in line with market
expectations. With this, the policy rate has been hiked by 250 bps in current rate hike
cycle (Effective rate hike is higher at 315 bps). While the market had expected RBI to
change its stance to neutral in Feb policy itself, the continuation of previous policy of
‘withdrawal of accommodation’ and inflation vigilant presser possibly indicates
future rate actions will be data dependent and based on evolving outlook for
inflation. RBI has revised downward inflation projection for FY23 to 6.5% (Prior: 6.7%) on
evolving trends and has projected FY24 inflation to moderate to 5.3%.
Growth:
Economic growth moderated to 4.4%y/y in 3Q FY23 (2Q FY23: 6.3% y/y) driven mainly
by adverse base effect, muted consumption (private & government) growth. That
said, 3Q projections were in line with RBI’s estimates. Capex growth continued to
remain robust, while drag from net exports on the growth reduced on lower import
growth. Economic growth in FY23 is estimated to grow robustly at 7% (FY22: 9.05%)
Inflation:
After last couple of months of below consensus print, January headline CPI Inflation
number came in higher at 6.52%y/y (Previous month: 5.72%y/y; Consensus
expectations (6.2%y/y). This was above 6% mark (RBI’s upper band), after below 6%
print in previous two months. Apart from unfavourable base effect, higher than
seasonal increase in prices of food, sticky clothing and footwear and services prices
pushed up headline print. Market core remained elevated at 6.09% (Previous: 6.08%)
driven mainly by sticky clothing & footwear and higher momentum in health and
personal care.
While the average YTD FY23 inflation print stood elevated at 6.78%y/y (FY22: 5.51% y/y).
Fiscal:
Apr-Jan 2022 Tax collections continued to remain robust, while expenditure growth
accelerated from September onwards - driven mainly by revenue expenditure. As a
result, despite recent pick-up in expenditure, fiscal deficit remained ~68% of BE
(pre-pandemic trend: 110%). Robust February GST data indicates that overall tax
collections till date continues to remain robust. Trends in current fiscal year indicates
that although the government has revised upward tax as well as expenditure targets
in the Union Budget, the target are likely to be met, without much pressure.
External Sector:
Trade deficit improved to US$17.7 bn (lowest since Jan 2022 and much lower than first
three quarter average of US$23 bn). Improvement was primarily driven by broad
based decline in imports (Oil and core imports). Apr-Jan FY 23 exports grew at 8%,
while imports grew at 22% driven primarily by oil imports (price +value effect) and
resilient nature of core imports.
After witnessing net inflow in November-December, there was net FPI outflows in
January (US$3.2 bn) and marginal outflow in Feb (US$0.5bn), although there was FPI
inflows in debt. After appreciating marginally in January 2023, Rupee depreciated by
around 0.9%m/m in February, tracking strong dollar index and sharp rise in UST.
Average Rupee was ~82.6 during the month (Jan 2023: 81.90, Oct-Dec 2022:82; Sep:
80.23, Avg July-Aug: 79.6, Jun: 78.07, May: 77.27, Apr: 76.2). YTD FY2023 rupee
depreciated ~ 9% against dollar.
Yield Levels & Spreads:
G-sec market started the month on positive note on fiscal consolidation and
capex-oriented Union Budget. Hawkish RBI’s Feb-23 monetary policy (keeping open
option of future rate hike), followed by higher than expectation monthly inflation
prices - resulted in yields moving up. Also, China reopening story, heat wave, El Nino
related drought news along with major concern that US Federal Reserves will hike
more than market expectations resulted in yield moving up further. Starting the
month at 7.28%, 10-year G-sec rose quickly to 7.35-7.37 range post policy and inflation
data, only to jump further high up to 7.40 lvls on rising Federal Policy concerns. It
closed the month at 7.43 levels (Jan: 7.36%, Dec : 7.33%, Nov end : 7.28%, Oct: 7.45%, Sep:
7.39%).
10-year Term premia (10 yr over 365 days) declined sharply to average ~25 bps during
the month, on sharp rise in 1 year T-bill cut-offs (Jan: 44 bps, Dec: 42bps, Nov: 46 bps,
Oct: 58 bps, Sep: 77 bps).
While 10 yr SDL yields tracked 10-year G-sec yields, the movement was range-bound
for most part of the month, only to rise a bit towards the end of month. It traded in
range of 7.60-7.65% in first three weeks and rose toward end of the month at 7.68%
(Jan-23: 7.63%, Dec: 7.55%, Nov: 7.58%, Oct: 7.76%, Aug-Sep: 7.52-7.57%). Feb-23 SDL
primary supply stood at Rs.84,220 cr (Jan-23: Rs. 77,651 cr, Nov-Dec-22: ~55,000 cr, Oct
22: 70,450 cr, May-Sep 22 monthly average ~50,000 cr). The average spread between
10 yr SDL over G-sec eased to 25 bps during the month (Jan: 23 bps, Dec: 26 bps, Nov:
33 bps, Oct: 29 bps, Sep: 28 bps).
Tracking G-sec, AAA bonds yield moved up during the month. 10 yr AAA PSU close the
month at 7.77% (Jan-23: 7.64%, Dec: 7.65%, Nov end: 7.58%, Oct end: 7.76%, Sep end:
7.76%).
Inflation:
Global inflation continued to ease into January, driven mainly by favourable base
effect. That said, the monthly momentum has shown a pick-up driven by strong
China demand and resilient demand in both Advanced and emerging economies.
Global food prices were in disinflation for third consecutive month, with IMF’s FAO
Food Price Index (FFPI) down by 3%y/y vis-à-vis record 34%y/y in March 2022. That
said, Inflation trajectory is expected to remain above global central bankers’ comfort
level in CY2023.
Policy rates:
Persistently strong inflation has forced central banks globally to front-load and
exercise larger hikes and simultaneously withdraw surplus liquidity at faster pace.
From December, central banks across globe from US Fed, ECB to RBI have opted to
reduce rate hike pace (i.e. to go slow on policy tightening) – to assess the impact of
previous rate hike given the time lag required for monetary transmission on real
economy. While that policy continued into new year, better than expected
hi-frequency indicators and sticky inflation might push global central bankers to hike
more. Still robust hi-frequency indicators might force US Fed to hike more than what
market is factoring in.
Financial Markets:
After peaking in Oct’22, US treasury yields have eased across curve during Nov
through January on peaking inflation rate, lower commodity prices and growth
moderation expectations. The yields have rose sharply in Feb driven by still strong
momentum in inflation, strong labour market and expectations that peak policy rate
is likely to be much higher than market expectations. This reflected in dollar index as
UST, with further increase in invertedness of yield curve. The US 10 Yr Treasury bond
yield started the month on positive note at 3.40%, rose sharply to end of the month at
3.92% (Jan : 3.52%, Dec: 3.83%, Nov end: 3.68%, Oct end: 4.10%, Sep end: 3.83%).
After depreciating for three consecutive months, Dollar Index appreciated in
February by ~1% on US Fed Policy hike concerns.
Market View
- Domestic macros are improving. Directionally and qualitatively for external balances (current account deficit) and internal balances (fiscal deficit given Union Budget emphasis on fiscal consolidation and Capex focus). Even inflation trajectory of gradual decline in inflation is intact, although there is rising concerns of food inflation from heat wave and El-Nino related drought.
- Further, Global Central Bankers continued to remain hawkish and likely to maintain ‘Higher for longer’ stance during CY2023 as against market expectations of early exit. This may likely impact yield curve.
- While RBI hiked the rate by 25 bps in line with consensus view, the continuation of policy of ‘withdrawal of accommodation’ indicates future actions may be data-driven and on inflation and growth trajectory. Higher than expected January-23 inflation print and hawkish Fed has increased the probability of rate hike in April-23 policy.
Common Source:
RBI, CEIC, Finance Ministry, US Federal Reserve, Bank of England, ECB, JP Morgan CSO, MOSPI, IMF,
CGA, CCIL,
Budget Documents, NIMF Research.
Disclaimer:The information herein is meant only for general reading purposes and the
views being expressed only
constitute opinions and therefore cannot be considered as guidelines, recommendations or as a
professional guide
for the readers. The document has been prepared based on publicly available information, internally
developed
data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any
of their
directors, employees, associates or representatives (“entities & their associates”) do not assume any
responsibility
for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of
this
information are advised to rely on their own analysis, interpretations & investigations. Readers are
also advised to
seek independent professional advice in order to arrive at an informed investment decision. Entities &
their
associates including persons involved in the preparation or issuance of this material shall not be
liable in any way
for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including
on account of
lost profits arising from the information contained in this material. Recipient alone shall be fully
responsible for any
decision taken based on this document.