The much awaited central government borrowing calendar for first half of the next fiscal year was announced yesterday, and constituted the second bullish surprise for bonds after a lower than expected gross borrowing program announced in the budget. Owing to a comfortable cash balance situation, the government has opted to borrow only 53% of gross supply in H1 FY25 versus 58% done in H1 FY24. The distribution of borrowing is somewhat more skewed towards longer duration, with >= 30 year supply rising from 34% to 37%. This is presumably to accommodate the rising demand from insurance and pension investors. The data is summarized below.
The lower supply coincides with the run up to the bond index inclusion where, despite recent heavy buying already by FPIs, a lot of participation flows seem to be still pending. Also, average duration of purchases so far seems to be somewhat more conservative than that of the index, suggesting that appetite for duration should also pick up going forward. All told, the demand versus supply environment seems very favorable for government bonds, against a backdrop of a solid local macro-economic setting and a (hoped for) imminent turn in the global rate cycle. More on the latter below.
Recent Developments On Global Rate Expectations
Basis continued general strength in economic data, and unpleasant recent inflation surprises, market has significantly dialed back on rate cut expectations from the Fed. Market expectation currently stands at 75 bps of rate cuts for 2024, closer to Fed ‘expectations’ as derived from median dot plots of FOMC members. The reconciliation between market and Fed expectations should herald better market stability as is indeed getting seen in narrower ranges in US bond yields lately. However, this somewhat hangs by a thread as further data volatility may very well lead to another round of expectations rerating. The source of ‘hotter’ US data is well appreciated: a head-scratching rigid fiscal stance with refusal to consolidate deficit despite continued above trend growth. Even so, there is some evidence building that consumers at the lower end of the economic spectrum may now be facing stress. Indeed, aggregate retail sales data has lately been flagging slowdown in consumer demand.
The narrative ‘across the pond’ is somewhat different. Expectations are building for a dovish turn for ECB and BoE. Economic data is much less robust here and inflation dynamics relatively less sticky. Importantly, the notion of major central banks waiting for the Fed to cut first has already been dispensed with, with the Swiss central bank delivering a surprise rate cut recently. Finally, the much anticipated policy normalization from BoJ went through without a wrinkle. For an economy just having emerged from decades of worrying about too low inflation it is understandable that the central bank wants to go slow on monetary tightening, even as it was keen to normalize the policy setting. Ironically, the Japanese yen hit a fresh low in the days after the policy normalization. These constitute important balancers to the ‘US exceptionalism’ from a global bond yield and financial conditions perspective.
Finally, a word on RBI. The ‘backdoor’ hike from late last year has now been unwound with the central bank proactively infusing liquidity via forex operations. The size of this is notable. In our estimate RBI has infused close to INR 2 lakh crores of permanent liquidity via this route since end of December. As a result core liquidity is around INR 2.5 lakh crores currently; much higher than what we had expected earlier. This has been an important development and one which should reflect more fully in market performance, especially front end rates, starting the quarter ahead.
Investor Takeaways
We continue to believe that India fixed income is at an inflexion point basis the following factors:
1. A macro risk rerating underway basis current account dynamics, fiscal consolidation underway, and benign inflation drivers. Importantly, these are intertwined and should not just be looked at separately. As an example, we think how government fiscal deficit relates to current account deficit and what this implies for long term interest rates is still underappreciated. Also importantly, a lot of this evolution is policy driven (both government and RBI) and is not basis a benign accident.
2. The above rerating is happening at a scale of economy and market that is now too large for global investors to ignore.
3. The imminent bond index inclusion(s) is providing the requisite thrust to global investors to start looking at the Indian fixed income story more actively, despite occasional operation participation difficulties.
4. While risk of policy divergence is keeping dollar strength alive for now, more and more global investors are looking for diversification given the anticipated long term US fiscal trajectory. Thus higher US yields aren’t hurting allocation to strong macro-economic stories in the EM world.
Finally, against a relatively stable global backdrop as discussed above, RBI’s recent actions on liquidity have been positive and demand-supply dynamics for bonds are bullish.
Basis the above, we reiterate that the number one risk fixed income investors face currently is reinvestment risk: that is risk that maturing investments over the next few years may have to be reinvested at substantially lower yields. An assumption to our view is that of policy continuity since, as noted above, a lot of the macro economic improvement is policy driven and not serendipity.
Our conviction in the view and framework is strong enough for us to have made material changes to the fixed income platform over the past few months, as summarized below:
1. Active duration bond and gilt funds are approximately 90% in 30 year government bonds.
2. We have discontinued tactical roll down strategies in banking PSU and corporate bond funds since such strategies naturally expose investors to reinvestment risk down the line.
3. Floating rate fund has moved to a short term oriented strategy versus a low duration one earlier, in the satellite bucket.
Product Label:
1. Bandhan Banking & PSU Debt Fund: An open ended debt scheme predominantly investing in debt instruments of banks, Public Sector Undertakings, Public Financial Institutions and Municipal Bonds with Relatively High interest rate risk and Relatively Low Credit Risk.
2. Bandhan Corporate Bond Fund: An open ended debt scheme predominantly investing in AA+ and above rated corporate bonds with Relatively High interest rate risk and Relatively Low Credit Risk.
3. Bandhan Floating Rate Fund: An Open-ended Debt Scheme predominantly investing in floating rate instruments (including fixed rate instruments converted to floating rate exposures using swaps/derivatives) with Moderate Interest Rate Risk and Moderate Credit Risk.
Disclaimer:
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