Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Escalated Geo-political Risks: Inflation Pre-ponderance over
Monetary Policy
The month saw rising concerns about demand slowdown from China
(Virus and related lockdown, moderation in growth projections)
thereby raising concerns about global growth. At the same
time, lingering supply issues (extended war, volatility in
commodity and financial markets) resulted in sharp increase in
inflation across globe with sticky/persistent nature of its
outlook. In this backdrop, Central banks (both advanced and
emerging economies) are in aggressive tightening mode along
with rapid liquidity normalisation via quantitative tightening
(QT) mode.
Economic Growth:
With Russia-Ukraine war running into third month and seems
unlikely to close soon thereby leading to rise in
geo-political uncertainty, supply chain issues, across board
record high prices, growth concerns in China, record high
inflation and tight monetary and financial conditions. This in
turn has led slowdown in overall global growth momentum.
International organisations (World Bank, IMF) have sharply
revised down the growth forecast for CY2022. According to IMF,
global growth in 2022 is forecast to be around 3.6% (Jan 2022
estimate: 4.4%), with emerging economies likely to take major
hit. China’s growth forecast has been revised down to 5.1%
(Jan 2022: 5.5%), while Indian economy is projected to grow at
6.9% (Jan 2022: 7.7%).
Inflation:
March 2022 inflation for India came in as a shocker with
headline print at 6.95%y/y (Feb 2022: 6.07%y/y). This was much
higher than the consensus estimates of 6.4% y/y. Sequential
momentum in headline was much higher than the seasonality and
was broad-based indicating direct and indirect pass-through of
rising crude prices and supply issues. Core inflation rose
sharply to 6.52%y/y (after remaining ~6.20% lvls between Oct
21-Feb 22).
Headline number is now almost 1% over the higher bound of
RBI’s target range and expected to remain around similar
levels in Apr’22 on worsening global macros (high and elevated
commodities, lingering supply chain issues) and domestic
factors (rising cost of production, pick-up in demand). With
March quarter average at 6.4% and June quarter expected ~6%
plus on rising prices, the pressure on RBI to act is rising.
Globally, the inflation has been at elevated levels over last
couple of months, with March numbers across economies
reflecting sharp increase on back of crude oil shock. With
extended war between Russia and Ukraine, supply side issues
are likely to be exacerbated for extended time, making higher
inflation more entrenched. IMF, in its latest outlook, has
sharply revised upward inflation projections for both advanced
and emerging economies.
Monetary:
Reflecting its emerging dynamics, RBI, in early April-22
policy, while keeping key policy rate unchanged, started with
its normalisation process by increasing the lower end of LAF
corridor to 3.75% (from 3.35% since start of pandemic). Amid
rising uncertainty related to geo-political risks & its global
spill-over, RBI revised down FY23 growth projections (60 bps)
and sharply raised inflation projections (120 bps). It
restored the LAF corridor to pre-pandemic levels. Further, it
also asserted that inflation will henceforth take precedence
over the growth unlike pandemic times. It has moved from
ultra-accommodative policy to accommodative policy. Further,
with rising inflation risk rapidly, RBI in its off-cycle
meeting in early May’22, decided to hike the key policy rate
by 40 bps with clear indication front-loading the rate hikes
and embarked on the path of aggressive liquidity normalisation
(via CRR hike of 50 bps).
Globally, most central banks have already embarked on the path
of normalisation with most emerging economies taking lead. Now
with inflation risk lurking in backdrop of rising
geo-political risks, monetary policy tightening is being
followed by vigour (with India recently joining the club).
Many advanced economies have started process of rate/liquidity
normalisation. After hiking the rate by 25 bps in March-22,
the Fed Governor hiked the policy rate by 50 bps in early
May’22 meeting and mentioned 50 bps hike is on table for next
couple of meetings. It also announced its quantitative
tightening (QT) programme, with early start of Fed balance
sheet contraction from June 1, 2022. After hiking the rate in
every policy meeting since Dec 2021, Bank of England hiked the
rate by 25 bps in May’22 meeting on record high inflation
(March print: 7%). Euro Area is also witnessing sharp rise in
inflation due mercurial rise in fuel prices and early
indication from policy makers are for July/Sep hikes. With
most Advanced economies now in normalisation camp, only Bank
of Japan preferred to look at the inflation shock as temporary
and preferred to remain accommodative.
India’s External Sector & Global Update
Crude prices remained elevated and volatile on geo-political &
growth concerns. While they declined by 8%m/m to average
~US$105.8/barrel (Mar: US$115.6/barrel), they continued to
remain above US$100 mark for most part of the month. YTD CY22
crude rise has been sharp (37%). Given uncertainty related,
low inventory levels, supply issues and war, the crude prices
are expected to remain volatile as well as elevated in coming
months.
In the bond markets, US treasury yields rose sharply during
the month on account of record high inflation print, hawkish
Fed speak, elevated crude prices and geo-political risk. The
US 10 Yr Treasury bond yield started the month at 2.39%,
touched 2.93% levles mid-month, only to ease a bit to close
the month at 2.89% (Mar end: 2.32%, Feb end: 1.83%, Jan end:
1.79%, Sep through Dec: 1.5%-1.58% range, Aug end: 1.3%, July
end: 1.24%). On risk -off scenario, Dollar Index continued to
rise robustly by 2.2% m/m in Apr’22 and cross mark of 100. In
fact, it touched record high 103 towards end of month on rise
in risk-aversion. YTD Dollar index has rose by ~5%.
Back home, INR stabilised during Apr’22, after being in
depreciating mode since Feb on back of sharp rise in
geo-political tensions (Avg Apr’22: 76.09/US$, Mar: 76.26/US$,
Feb: 74.96/US$, Jan: 74.44/US$). Going forward, rupee is
likely to come under pressure on global cues. Like other
emerging economies, India has been witnessing net FPI outflows
since Oct 2021. This trend continued into Apr’22. Global
financial market volatility due to Russia-Ukraine conflict saw
net FPI outflows of US$ 3 bn in Apr’22 (lowered than witnessed
in Mar: US$6.5 bn, Feb: US$5 bn, Jan: US$3.8 bn) - driven
mainly by equity outflows. Since Oct, there has been net
outflow of ~US$24 bn. After a sharp decline in March (US$14
bn), the month saw decline of~US$6 bn in forex reserves to
US$600 bn by third week of Apr’22. However, auction and
maturity of forex swaps (US$10 bn) might have likely to led
higher drain to forex reserves by month end.
Yield Levels & Spreads:
Yields moved up sharply during the month post RBI policy in
early Apr’22. RBI has changed its stance and hiked lower bound
of LAF corridor. The 10 Yr benchmark started the month at
6.90% (Mar end close: 6.84%), jumped to 7.12% (on higher than
expected increase in lower bound of LAF corridor), rising
further to 7.23% on higher than expected inflation print and
close the month at 7.14% on global cues. 10 Term premium (10
yr over 365 days) stood on average ~238 bps (Nov-Mar : 222-228
bps range, Oct: 244 bps, Sep: 253 bps, Aug: 259 bps)
indicating steepness of yield curve.
Like Gsec, 10 yr SDL yields rose post RBI policy in early
Apr’22. It started the month at 7.19 lvls, rose to 7.35 post
policy, touched 40 lvls post inflation print and thereafter
eased and remained range-bound to close the month at 7.27%
(Mar end : 7.18%, Feb end: 7.10, Jan end: 7.24, Dec end:
6.99%, Nov end: 6.81%, Oct end: 6.92). 10 yr SDL was on
average ~7.29% (Previous: 7.18%). Apr’22 SDL primary supply
was miniscule at Rs.9,500 cr on robust revenue collections
(Mar : 1,03,665 cr, Feb : 52,118 cr, Jan: 79,535 cr, Dec:
Rs.54,385 cr, Nov: Rs. 43,502 cr, Avg Aug-Oct: 55,000 cr). The
spread between 10 yr SDL over G-sec eased to 21 bps (Mar : 35
bps, Feb : 37 bps, Jan : 53, Dec; 47, Nov: 54 bps, Oct: 57
bps, Sep: 61 bps, Aug:71 bps).
Taking cues from G-sec and SDL curve dynamics, AAA bonds rose
post policy. 10 yr AAA PSU started the month at 7.03%, rose to
7.20% post policy and jump to 7.33% post inflation print and
close the month at 7.35% (Mar end : 7.05%, Feb end: 7.02%, Jan
end: 7.10%, Dec end: 6.84%, Nov end: 6.88%, Oct end: 6.91%,
Sep end: 6.80%, Aug end: 6.93%).
Market View
- Normalisation of Liquidity Adjustment Facility (LAF) corridor via hike in lower bound of LAF corridor (in Apr’22 and now surprise rate hike by RBI (in early May’22 policy) has clearly indicated policy of normalisation has begun in India. Especially May’22 hike is clear indication of front-loaded and aggressive nature of policy. Now inflation has taken clear precedence over the growth and based on evolving inflation trajectory, June-22 and August-22 seems like live policy. As a result, post surprise May’22 rate hike, yield curve across curve rose sharply by around 25-40 bps reflecting to hawkish nature of policy. Further, we believe market reaction is primarily to not just 40 bps hike repo rate, but its front-loaded nature and hence would likely to remain volatile over next couple of days before stabilising.
- In early May’22 meeting, the US Fed hiked the key policy rate by 50 bps (in line with market expectations). Further, it decided to kickstart QT (quantitative tightening) from June 1, 2022 (early start) by adjusting reinvestment of securities. Normalisation process (rates and liquidity) of US Fed has already started impacting yields and flows to emerging markets (including India). While the latest move was already anticipated by the market, the market will watch out of future rate & QT trajectory and sound bite from US Fed.
- That said, the evolving geopolitical risk maycontinue to be determining factor for growth, inflation, fiscal, trade, currency, supply chain and financial market outlook.
We believe with front-loading nature of RBI’s rate hike and
aggressive normalisation approach globally, Indian fixed
income market is likely to remain volatile with selling bias
in coming days, with selling bias on every rally till market
stabilise.
Common Source:
Bloomberg, RBI, CEIC, Finance Ministry of India, 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.