Debt Monthly View for February 2024

The 10-year US treasury yields inched higher during February 2024 reaching 4.25% as of month end against 3.89% at the beginning of February. The swing in yields was broadly in response to the February CPI inflation in the US coming higher than market expectation at 3.1% y-o-y. Following strong employment numbers and higher than expected inflation print, market participants dialed back some of the rate cut expectation pushing treasury yields higher.

On the other hand, the Indian bond yields saw a sharp drop at the start of the month following the announcement of the Interim Budget on February 1, 2024. In the interim budget, the government pegged the fiscal deficit target for FY25 below market expectation at 5.1% of GDP as against 5.8% in FY24. The government also lowered the gross market borrowing target for FY25 to Rs. 14.1 trillion vs Rs. 15.4 trillion in FY24.

The 10-year benchmark government bond yield fell to 7.07% from 7.14% post the budget announcement and later hovered in the 7.05% to 7.11% range throughout the month.

Money market rates saw some relative easing during the month amid tight banking system liquidity. The 3-months Treasury bill yield was trading near 6.89% as of February end against 7.04% in January. Yield on the short-term money market securities such as commercial paper (CP) / certificate of deposit (CD) however broadly traded at the same levels as last month. At the month end, 3 months maturity AAA PSU papers were trading around yields of 7.70%-7.75%.

Liquidity condition remained tight through the month with daily banking system liquidity deficit peaking around Rs 2.5 trillion (Rs 1.85 trillion monthly average). Towards the end of the month, the banking system liquidity saw some easing owing to pick up in government spending. Much of the prevailing tight liquidity was due to slow pace of government spending while the core liquidity (banking system liquidity adjusted for government cash balance) continued to remain in a surplus of around Rs. 1.5 trillion.

The RBI kept the policy rates unchanged (5:1 majority) as widely expected while keeping the policy stance as ‘withdrawal of accommodation’ in its bi-monthly monetary policy meeting on the 8th of February 2024. The governor highlighted that CPI inflation is still above the RBI’s 4% goal and the transmission of past monetary policy actions is still incomplete in the credit market.

The CPI inflation eased to three months low at 5.1% in January 2024 aided by a decline in vegetable prices (Headline CPI at 5.7% last month and 6.5% a year ago). While the headline CPI inflation was elevated lately owing to volatility in food prices, the Core CPI, (which excludes food and energy prices) has been declining consistently over the last twelve months (3.5% y-o-y for January 24, below RBI’s 4% target).

The RBI projects headline CPI inflation to average at 4.5% in FY25 vs 5.4% in FY24. The Feb monetary policy set FY25 GDP growth at 7% and FY24 projection was raised to 7.3% from 7% earlier.

The October - December 2023 quarter GDP growth was recorded at 8.4% y-o-y, much higher than market expectations. GVA came in at 6.5% y-o-y indicating India’s strong growth momentum.

Outlook

We hold a positive outlook on the fixed income market considering:

• Favourable demand supply mix in government bonds amid falling fiscal deficit and reduced supply of bonds.
• Increasing participation by foreign investors following global index inclusion
• Declining Inflation trend
• Possibility of rate cuts by the RBI in H2 FY25
• Softening global environment with declining global growth and expectation of rate cuts by major central banks

We expect bond yields to decline over the coming months. With higher starting yield and possibility of decline in bond yields over medium term, return potential of fixed-income funds investing in long duration bonds look good. Long term bonds tend to perform better during falling interest rate environment.

Investors with 2-3 years holding period can consider dynamic bond funds for their fixed income allocation. Dynamic bond funds have flexibility to change the portfolio positioning as per the evolving market conditions. This makes dynamic bond funds better suited for the long-term investors in this volatile macro environment.

Investors with a short-term investment horizon and with little desire to take risks, can invest in liquid funds which invest in government securities and do not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.

Source: RBI, Bloomberg

Above article is authored by Quantum.

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