Not walking alone: A bond and macro update (Opinion)

19

By Suyash Choudhary
The government announced a series of steps aimed at providing some relief against the unprecedented commodity price shocks being felt post the geopolitical escalations. Chief amongst these was a Rs 8 and Rs 6 cut, respectively in excise duties on petrol and diesel prices per litre. Apart from these, a Rs 200 subsidy on LPG cylinders has been provided under the Ujjwala scheme. Additionally, customs duties are being cut on some inputs for plastic and steel. Finally, export duties are being hiked on items like pellets, iron ore, and some steel products. All told, these constitute a substantial set of measures and come at just the time when monetary policy was turning quite wary of the developing supply side inflation dynamics. Importantly, this also constitutes a signal that government is equally committed to the battle against inflation (media reports suggest more measures may be taken later if required).

Some Observations

A government unwilling to expand fiscal deficit through resisting subsidizing parts of the consumer basket should ordinarily be seen as complementing monetary policy action in curbing inflation. This is because monetary policy acts to curb aggregate demand by weighing down on parts of its components (Private consumption, Investments, Government consumption, Net exports). As can be seen, an expansion in government spending works at cross-currents to this. Thus by extension, a government unwilling to expand deficit is working in tandem with monetary policy. However, a different approach may have been required in case of fuel items and some other essential inputs owing to the risk of cascade of these prices through the entire manufacturing value chain. It is for this reason, presumably, that RBI/MPC members seem to have been encouraging the government to act. If media reports are to be believed, it is disappointment on this front that may have led monetary policy to come on the front foot on rate adjustments. A theoretical question may be asked to clarify the point: Would the inter-meeting hike have occurred if the government had announced these steps ahead of that meeting?

We don’t really know the answer to the above question. Notwithstanding that, with a government now seemingly also focussed on bearing the burden (and after having made a hefty ‘down-payment’ on the same with these latest measures) the pressure on monetary policy should lessen, ceteris paribus. Now this statement needs to be interpreted carefully. After the April policy and before the May inter-meeting hike, the market as per the swap curves was pricing in 275 bps hikes over two years from the overnight rate of 3.75 per cent then. Around 75–100 bps of these were expected in year two. Post the inter-meeting hike, however, the market started discounting all these hikes (and a bit more) in year one itself. It is possible, though not immediately observable, that the market unwinds part of the frenzied pace of hikes in year one that has been priced in post the inter-meeting hike.

On the bond curve, post the inter-meeting hike there was flattening between 1 and 4 years and between 4 and 10 years. While this makes sense, the residual spread left between 1 and 4 years was still quite large given that the spread between 4 and 10 years had reduced materially. If market was bringing forward all its tightening expectation to the next 1 year, then the maximum flattening pressure should have been felt on the spread between 1 and 4 years. Instead it is 4 to 10 year spread that reduced aggressively while leaving 1 to 4 years reasonably positive sloping. This implied two things: Market was still pricing in higher forward rates (2 years and 3 years rates 1 year from now versus where they were currently), thereby still expecting year 2 rate hikes unlike the swap curve; If the reason for this steepness was just bond supply premium on yields, then the 10 year and beyond was heavily ignoring this supply premium.

Going Forward

If some of market’s upfronted rate hike expectations were to unwind going forward, then it is logical to expect some giving away also on the 4–10 year flattening that has occurred just over the past month. In fact, the market will likely have to price in a larger bond supply premium as well given the new fiscal uncertainties down the line post these (and later may be more) fiscal measures. This will likely put more pressure for this spread to expand. It is to be noted that basis recent action, this spread is now largely in line with the pre-Covid era and is almost completely ignoring the additional bond supply premium that needs to be built in for the new regime of higher government deficit over multiple years.

Our long standing overweight 4 – 5 year strategy has been stressed heavily over the past month owing to the market dynamics as discussed above. However, basis our view going forward we think this segment should now start to enjoy a relative tailwind as market partly unwinds rate hike fears and builds back bond supply premium. To be clear, there is little change in our underlying expectation about the likely rate hike trajectory ahead. We continue to think that monetary policy makers want to achieve a position of relative neutrality soon enough. This they seem to have defined around the pre-Covid repo rate of 5.15%. However, unlike the market consensus, we continue to think that the pace of hikes thereafter will be much more measured with the repo rate probably peaking out under the 6% mark. The premise of this expectation, as discussed many times before comes from our assessment of India’s total fiscal and monetary policy response post Covid and the normalisation already underway for monetary policy; Our underlying growth trajectory and the characterisation of most of the inflation currently in play; Central banks’ having to hike in what is a clearly slowing global cycle and the related point that most of them are unlikely to have a multi-year adjustment runway.

Another observation is noteworthy basis the above. We find a lot of favour in the market today for strategies anchored around the 1 year point. While these may sound ‘surer’ in an otherwise volatile environment, there are nevertheless 2 deficiencies in the argument here in our view:

As noted above, 1 to 4 years spread is still very large thus implying quite steep forward curves (3 years 1 year from now, or 2 years 2 years from now if one were to consider 2 years to 4 years spread currently). By focussing on just 1 year (or 2 years) investors are effectively not choosing to ‘own’ these steep forward curves.

Investors are potentially courting re-investment risks 1–2 years down the line by ignoring 4–5 years in favour of 1-2 years. Even if one were to consider swap pricing (which is excessive in our view) the rate hike cycle will probably be done by year 1. Most likely, given what we think and what we are observing of the global macro cycle, by then the narrative on many central banks would have materially changed. The point about reinvestment risk is especially applicable since, as noted above, the forward curves are so steep. On a related note, tactical products like floating rate bonds may have limited shelf life as well given the nature of this cycle as analysed above.

(Suyash Choudhary is Head, Fixed Income, IDFC AMC)

Source: IANS

Post Disclaimer by BhaskarLive.in

The information contained in this post is source form the news agency or PR agency. We do not take any responsibility of accuracy of information. We have not made any modification or changes in original source content. This information only for general information purposes only. The information is provided by BhaskarLive.in and while we Endeavour to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the website or the information, products, services, or related graphics contained on the post for any purpose.

Next Story

Share Market Closing Bell: Nifty ends above 15,500, Sensex gains 443 pts

Share Market Closing Bell: Nifty ends above 15,500, Sensex gains 443 pts

On a weekly expiry day, Nifty opened on positive note and have a dip to make an intraday low at 15367.50 level but showed bounce back moment as managed to close at 15556.65 level with a gain of 143 points. Bank Nifty closed the session at 33135 level with a gain of 289.70 points. 45 Out of Nifty 50 ended in green which suggest broad based buying.

All the sectoral indices managed to close in green expect Energy while Nifty Auto was top gainer. Among Nifty Stock, MARUTI, EICHERMOT, HEROMOTOCO & M&M were the top gainers, While RELIANCE, COALINDIA, POWERGRID & GRASIM were the prima laggards. India VIX closed at 20.88 level with a loss of 1.97%. On Technical Front, The Nifty has formed bullish candle but faced resistance at 21 Four-Hourly Moving Average i.e., 15647 which suggest crossing above the same can show more upside rally.

Nifty has been trading in range of 15200-15700 level while breaching either side can suggest further direction of breakouts. Nifty has given above 50-Hourly Moving Averages which indicate it can show upside moment in the counter. On the Nifty OI Data, On the call side ,the highest OI witnessed at 16000 level while on the put side was at 15500 Niftg level followed by 15300 levels. The momentum indicators Stochastic is trading with a positive crossover on a daily chart which suggest northward journey in the Nifty.

The Nifty may find support around 15200 levels while on the upside 15700 may act as an immediate hurdle. On the other hand, Bank Nifty has support at 32300 levels while resistance at 33800 levels.

Overall, Sector specific momentum has been observed, crossing above 15700 Nifty can show more upside rally.

Market entering into buy on dips pattern.

Palak Kothari
Senior Technical Analyst
Choice Broking

Source: Choice India

Post Disclaimer by BhaskarLive.in

The information contained in this post is source form the news agency or PR agency. We do not take any responsibility of accuracy of information. We have not made any modification or changes in original source content. This information only for general information purposes only. The information is provided by BhaskarLive.in and while we Endeavour to keep the information up to date and correct, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the website or the information, products, services, or related graphics contained on the post for any purpose.

LEAVE A REPLY

Please enter your comment!
Please enter your name here