Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Data-dependent Central Bankers & gradually declining inflation
Financial year (FY24) started on a good note, with RBI shifting to data-dependency
mode in early April-23 meet, followed by US Fed in early May-23. After accelerating a
bit in January-February, sequential momentum in inflation eased, with annual growth
in inflation coming down faster aided by favourable base effect. That said, resilient
global growth amid tight financial conditions leading to recession probability getting
pushed forward to 2H CY2023.
India
Monetary Policy:
After aggressively front-loading in every single meeting of FY23 (total 250 bps in
current rate hike cycle), the RBI left the key policy rates unchanged in April-23
meeting. This came as a surprise for markets, since consensus expected 25 bps hike.
Rationale behind the pause was primarily: FY24 inflation to moderate to average
5.2%y/y (FY23: ~6.7%) & to assess the cumulative impact of rate hikes in current cycle
on real economy. With current inflation above RBI’s upper bound, the RBI continues to
focus on ‘withdrawal of accommodative’ stance - to ensure that inflation
progressively aligns with the target.
Inflation:
After remaining elevated at average ~6.5% in Jan-Feb 2023, headline CPI eased to
5.66%y/y in March aided by favourable base effect and broad-based lower
sequential momentum. FY23 saw average inflation at 6.66% (higher than FY22
average: 5.51%; FY21 average: 6.18%). That said, year saw only three months print
below 6% mark (Nov & Dec 2022 & latest). Reason: Broad-based rise in price level
driven by pandemic, war and supply issues. Core inflation declined to 5.78%y/y in
March (Lowest since July 22, Sep through Feb 2023 avg: 6.05%). That said, Core
inflation continues to stay sticky for second consecutive year. FY23 core inflation
stood at average 6.1%. (FY22 average: 6%)
External Sector:
March 2023 Trade deficit widen to US$19.7 bn after surprising on downside in
January-February (Average:US$16.4 bn). While March export improved on
seasonality, robust imports (especially core imports) increased the trade deficit. 4Q
Trade deficit stood at US$17.5 bn as against first three quarter average for FY23 of
US$24 bn). The financial year ended with record high trade deficit ~US$270 bn (FY22:
US$190 bn) - driven primarily by sharp rise in oil and core imports. That said, net
services export continued to register robust growth for second consecutive year.
FY24 started on good note, with net inflow of US$1.7 bn in Apr (4Q FY23: net outflow of
US$3 bn; FY23: net outflow of US$5.5 bn). Rupee continued to appreciate for second
month in row, albeit marginally. Average Rupee was ~82 during the month (Mar: 82.3).
Rupee has appreciated by 1.2% against dollar in CY23 till date.
Yield Levels & Spreads:
Fixed income yields eased across the curve on the RBI’s surprise pause in early April
meeting, strong investor demand and rise in financial concerns towards end of
month. G-sec yields declined with 10-year G-sec easing from 7.31% at the start of the
month to 7.20 lvls post RBI meeting and eased further to 7.10 lvls in the last week -
driven by global financial stability concerns. It closed the month at 7.12% (Mar: 7.31%,
Feb: 7.43%, Jan: 7.36%).
10-year Term premia (10 yr over 365 days) rose during the month to average ~17 bps
- on relatively sharp decline in 1 year T-bill yield. (Mar: ~10 bps; Feb: 25 bps, Jan: 44 bps).
Like G-sec, SDL yields moved down on dovish monetary policy, lower supply and
global cues. 10 yr SDL traded in range of 7.46-7.66% to close the month at 7.46% (Mar:
7.64%; Feb: 7.68%, Jan: 7.63%). April SDL primary supply stood at ~Rs.22,300 cr in line with
seasonality (Mar: 1,39,000 cr, Feb: ~Rs. 84,000 cr, Jan: ~Rs. 78,000 cr). The average
spread between 10 yr SDL over G-sec increased to 38 bps during the month (Mar: 32
bps, Feb: 25 bps, Jan: 23 bps).
Like G-sec, AAA bonds yields eased during the month, with 10 yr AAA PSU moving in the
range of 7.50-7.70% to close the month at 7.50% (Mar: 7.69%, Feb: 7.77%, Jan: 7.64%).
Global
Inflation:
After picking up in January-February, the sequential momentum in global inflation
eased a bit in March. Global food prices were in disinflation for fifth consecutive
month, with IMF’s FAO food index down by 22%y/y vis-à-vis record 34%y/y one year
prior. That said, Inflation trajectory is expected to remain above global central
bankers’ comfort level for most part of CY2023.
Policy rates:
After raising rates sharply since March 2022, US Fed raised the policy rate by 25 bps
to 5.25% (total hike in cycle: 500 bps). From being aggressive, Fed Governor indicated
that further rate action will be data dependent. With real policy rate (policy rate
adjusted against 1 year ahead inflation projections) at 2%, the real rates were already
in restrictive zone. This along with lag impact of cumulative rate hikes till date,
financial stability issues would help in keeping credit conditions tight and thereby
help in bringing down inflation over time.
Financial Markets:
US treasury yields eased a bit on NFP (non-farm payroll) data in line with consensus
and monthly print lower than expectations - raising the hopes that rates have
peaked. Strong data in second half and financial stability concerns in second half
kept the rates volatile. After starting the month at 3.43%, the US 10 Yr Treasury bond
yield eased to 3.30 and moved in range of 3.3-3.52% in first half and then rose on
better-than-expected growth data in third week only to ease again by financial
stability concerns. 10 yr UST closed the month at 3.44% (Mar: 3.48%, Feb: 3.92%, Jan:
3.52%). Dollar Index depreciated by ~2% in April, after marginally appreciating in
March.
Market View
- In a surprise move, RBI left policy rates unchanged in April-2023 policy. While it did highlight upside risk to inflation and indicated that it will be data-dependent, the current policy rate is likely to be terminal rate, since RBI has revised down the FY24 inflation projections. Hence, unless macro-data (growth, inflation) surprise on upside, policy rate has probably peak out.
- While Fed has clearly indicated data-dependency nature of future policy actions, dovish comments in post policy press conference suggest rates have probably peaked out in United States.
- Going forward, given the peaking rate narrative & the attractive current absolute yields, the risk-return dynamics might favour reasonable allocation to fixed income.
- Intermediate duration (2 to 6 years) provides the benefits of peak rates narrative & potential curve steepening. Selective credit allocation within this space could provide further cushion.
- Directional change in rate trajectory is an above median probability event, thereby making limited allocation to duration a fair risk.
Common Source:
RBI, CEIC, Finance Ministry, US Federal Reserve, JP Morgan CSO, MOSPI, IMF, CGA, CCIL, NIMF Internal Research.
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