July 05, 2021
Fixed Income Monthly Commentary – June 2021
The calm in the bond market broke by a sudden jump in inflation last month. The CPI inflation for the month of May 2021 (data released on June 14, 2021) surged to 6.3% in year-on-year terms. It was meaningfully higher than the broader market forecast of about 5.4% inflation.
The price surge was across the board. It prompted a significant upward revision in the inflation estimate for the whole of FY22. Headline CPI inflation is now expected to average around 6.0% in FY22. Earlier forecasts were around 5.1%.
It also changed the market expectation of the policy normalization timeline. With acceleration in inflation momentum, the RBI may start policy normalization sooner than later. It may withdraw the excess liquidity first and then move to rate hikes.
The bond market reacted sharply to the inflation surprise. Bond yields moved up by about 10-20 basis points across the curve except for the 10-year benchmark bond that moved up by only 4-basis points. Divergence in the 10-year Gsec was primarily due to RBI’s disproportionate intervention in security. As of June end, the 10-year benchmark Gsec closed at 6.05%.
The RBI continues to intervene heavily in the bond market. The monetary policy meeting at the start of the month raised the quantum of the GSAP program. In Q2 FY22, the RBI will purchase government bonds of Rs. 1.2 trillion under GSAP 2.0. Furthermore, it has been actively intervening in weekly debt auctions by devolving and canceling auctions to keep yields at lower levels.
RBI’s tactical interventions and committed bond purchases under GSAP will continue to support the bond market in the near term. However, the macro backdrop has turned adverse for the bond market.
The brent crude oil price is sustaining above USD 75 per barrel. Given the sharp pick-up in economic activity globally and the gradual opening up of economies, it may remain elevated for some time. In the near term bond market will closely follow the movement in crude oil prices.
Inflation is picking up globally. CPI inflation in the US surged to 5% in May 2021. It is the highest US CPI reading in 13 years. Many of the FOMC (US Fed policy rate setting) members are openly advocating for reducing the size of asset purchases and pursue rate increases sooner than earlier envisaged. In the June FOMC meeting, the FED acknowledged the risk of inflation picking up. It raised the dot plot (members' expectation of future policy rates) higher, implying at least ~ 2 rate hikes in 2023.
There is enough evidence that the monetary policy cycle is about to turn globally. It could have a significant impact on emerging markets like India that depends on external capital flows.
Even in the domestic economy, inflation has started to feed into future inflation expectations. The household inflation expectation survey of the RBI shows that households are expecting inflation to pick up in the future. In FY22, headline CPI inflation is expected to touch the upper threshold of the RBI’s inflation target.
In the August monetary policy meeting, we expect the RBI to raise its inflation forecast closer to 6% (current estimate of 5.1%) and change its forward guidance accordingly to factor in the inflation risk. It may start withdrawing the excess liquidity and hiking policy rates by the end of 2021, provided economic growth sustains the current trend.
In our opinion, inflation and monetary policy normalization will play a more crucial role in shaping the interest rate trajectory over the medium term. We also argue that bond yields have already bottomed out in this cycle and are likely to move higher over the next 2-3 years.
Given the expectation of rising interest rates, it would be prudent for investors to focus on shorter-maturity funds that impact less when yields rise. Remember bond prices and debt funds’ NAV fall when market yields move up.
Conservative investors should stick to very short maturity debt categories like the liquid fund. Investors with a longer holding period and an appetite to tolerate intermittent volatility could consider dynamic bond funds. These funds can change the portfolio’s risk profile depending on evolving market situations.
We also suggest investors lower their return expectation from debt funds as the potential for capital gains will be limited going forward.
|Name of the Scheme||This product is suitable for investors who are seeking*||Riskometer|
|Quantum Dynamic Bond Fund|
(An Open Ended Dynamic Debt Scheme Investing Across Duration)
|• Regular income over short to medium term and capital appreciation|
• Investment in Debt / Money Market Instruments / Government Securities
Investors understand that their principal will be at Low to Moderate Risk
|Quantum Liquid Fund|
(An Open Ended Liquid Scheme)
|• Income over the short term|
• Investments in debt / money market instruments
Investors understand that their principal will be at Low risk
* Investors should consult their financial advisers if in doubt about whether the product is suitable for them.
The Risk Level of the Scheme in the Risk-o-Meter is based on the portfolio of the scheme as on May 31, 2021.
Disclaimer, Statutory Details & Risk Factors:
The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.
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Please visit – www.QuantumAMC.com to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.