In line with market expectations, the RBI MPC decided raise policy rates by 50 bps. The decision to raise rates was unanimous. The market was relieved that there were no further liquidity tightening measures following on the 50bps CRR increase in May.
The policy confirms RBI’s tilt now to combating inflation over supporting growth. Nevertheless, policy rates remain very accommodative, i.e. the repo rate is well below the current and projected rates of inflation. The change in language around policy stance in our view has made a highly complicated stance to a “complicated stance.”
Source: RBI Monetary Policy Statement & RBI post policy press conference dated 4th May 2022 & 8th June 2022
The policy stance is no longer a guide to the future course of monetary policy. Instead the statement seems to suggest that further policy actions may be necessary to contain inflation.
The markets in the build up to the policy saw rates across the curve rise by 10-15 bps. Post policy, the markets corrected some of those losses however rates gradually returned to previous day levels towards the end of the day. At the time of writing this note, the 10-year G-Sec was trading at 7.49% down 2 bps from the day earlier.
Source: RBI monetary policy statement dated 8th June 2022
The RBI’s statement today, was largely a non-event for the market since the market has priced in a large portion of rate hikes. Volatility in the bond markets that were seen in the last few months have been on account of the RBI recognizing headwinds that the markets perceived well ahead of time.
By projecting inflation at 5.8% by March 2023, the target to have policy rate above the rate of inflation implies a terminal repo rate in this hiking cycle of 6% or more. Market pricing for the terminal repo rate (as evidenced by the steep yield curve and OIS rates) already was above 6%.
Incrementally the evolution of actual inflation and liquidity management will drive market trajectory.
Since the start of the year, long-term yields have already risen by over 100 bps. Short-term yields have risen by 150+ bps. For investors, the sharp rise in yields means that markets have already priced in the worst of the rate movements. We believe the markets have priced overnight rates rising to 6%+ over the medium term. With current repo rates at 4.90% this implies 100+ bps of incremental rate hikes factored into bond yields.
The current G-Sec yield curve post 4 years is trading flat with a 4X10 year spread materially below long term averages. Similar trends are visible in the corporate and SDL curve. We had been playing for the curve flattening theme since January across our active portfolios and were using a barbell strategy to build portfolios within stated investment mandates without taking direct exposure to the 1-4-year segment. Now as the theme has played out, we have been recalibrated our portfolios.
The stance changes on liquidity and the fast tracking of neutralizing liquidity is likely to have an impact on corporate spreads especially AAA V/s G-Sec. In the interim period, as spreads widen, investors would be better suited to favor strategies with a G-Sec & SDL bias.
The current yield curve presents material opportunities for investors in the 4-7-year segment. This category also offers significant margin of safety given the steepness of the curve. For investors with medium term investment horizon (3 Years+), incremental allocations to duration may offer significant risk reward opportunities. For investors with short term investment horizons (6 months - 2 years) floating rate strategies continue to remain attractive as interest rate resets and premiums offer competitive ‘carry’ and low volatility. Credits can also be considered as ideal ‘carry’ solutions in the current environment.
Allocation and strategy is based on the current market conditions and is subject to changes depending on the fund manager’s view of the markets. Data as on 31st May 2022
* Investors should consult their financial advisers if in doubt about whether the product is suitable for them.
Source of Data: RBI Governor’ Statement, RBI Monetary Policy Statement & RBI post policy press conference dated 8th June 2022, Axis MF Research
This document represents the views of Axis Asset Management Co. Ltd. and must not be taken as the basis for an investment decision. Neither Axis Mutual Fund, Axis Mutual Fund Trustee Limited nor Axis Asset Management Company Limited, its Directors or associates shall be liable for any damages including lost revenue or lost profits that may arise from the use of the information contained herein. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The material is prepared for general communication and should not be treated as research report. The data used in this material is obtained by Axis AMC from the sources which it considers reliable.
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