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 favour 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. |
