2018 was an eventful year for bond markets. A surprise rate hike by RBI after several months of status-quo, change in RBI leadership and liquidity injection through open market operations were key events initiated by the central bank.
On macroeconomic front, the bottoming of retail inflation, the sharp rise and fall in oil prices and depreciation in rupee influenced markets. The banking system liquidity too turned from positive to negative during the year.
We also saw g-sec yields rising over 8% before closing the year near 7.25% levels. In fact, among the various categories of bonds, only g-secs saw a fall in yields on an annual basis (around 7.25% in December compared to 7.40% in January). Corporate bond yields, on the other hand, rose by around 0.50%.
On credit side, default by IL&FS, which was widely held and ongoing issues on banking front led to deep risk aversion. While the situation is slowly normalizing, it is expected to take a few quarters for things to stabilize.
How did funds react?
In line with the sharp decline in the g-sec yields, the 10-year constant maturity funds delivered highest returns amongst debt funds in 2018.
We talked with Bekxy Kuriakose, Head Fixed Income, Principal MF, Dhawal Dalal, CIO – Fixed Income, Edelweiss MF and Killol Pandya, Head Fixed Income, Essel Mutual Fund to understand market triggers in the near term and 2019-market outlook.
Key triggers
The next union budget and monetary policy meeting (MPC) will be key events for the debt market in the near term, said Bekxy. The budget will be keenly watched for any slippages in FY19 fiscal deficit target. Market would also look out for next year’s borrowing programme of gilts.
Fiscal deficit number for FY19 will be an important trigger for market participants, said Dhawal and Killol. The fiscal deficit as on November 2018 is already around 15% above the target for FY19. If the government considers carrying out farm loans waiver program, it could put further strain the fiscal position of the government, said Dhawal.
Elections will be the key event for the markets in 2019, shared Killol. According to him, the outcome of elections will determine the future policies of the government. This in turn will influence the direction and speed of interest rate movements. Bekxy too feels that the election outcome will be a key influencer of market sentiment and government policy.
Markets will also look out for movement in oil prices in the coming months, agree all of them. At the current levels, most oil producers are not breaking even. Thus, any reversal in crude oil prices, as and when it happens, will affect market sentiment negatively, added Dhawal. According to Bekxy, rise in oil prices will have a negative impact on inflation, which may influence RBI’s decision to hike rates.
There is a recent disinflationary trend in food inflation, which Dhawal believes is not sustainable over the long-term. The best of inflation data may be behind us, he added. Bekxy too feels that inflation may revert to mean during the year. However, even at that level, she feels that RBI is likely to maintain a neutral stance.
RBI’s stance on banking system liquidity will also be an important determinant of market sentiment, said Dhawal. While the current spate of Open Market Operation (OMO) have anchored g-sec yields lower since early October 2018, he expects RBI to taper the OMO program (RBI purchases g-secs from markets to infuse liquidity in the system) in the next financial year. Tapering of OMO bond purchase program may have a negative impact on g-sec yields amid commencement of the fresh borrowing program and political uncertainty.
Bekxy feels that RBI’s stance on OMOs, guidance on SLR (statutory liquidity ratio), capital committee recommendations will also influence markets in 2019.
Outlook
National elections will be an important event for the markets in the coming months, said Dhawal. The new government’s stance on fiscal deficit will influence market sentiments post-election, according to him. He recommends that investors take a cautious approach in the next few months as a pullback in inflation and oil prices could negatively affect market sentiments.
Bekxy expects RBI to change stance to neutral and remain on pause mode for most of the year unless there is a significant deterioration in growth (below 6-6.5%). RBI may go slow on OMO gilt purchases in FY20 if liquidity conditions normalize. It is possible RBI may also consider other tools for liquidity injection, she added. According to Bekxy, CPI inflation may mean revert to 4-5% levels during the year. She thinks that the credit spreads may narrow as risk aversion declines and normalizes.
Killol expects markets to be dynamic until 2019 general election. In the near term fiscal will remain under pressure, believes Killol. With RBI taking a data driven approach, participants shall also need to be aware of changing data points and global geo-political interconnectivities, he added.
Which funds should you recommend to your clients?
Conservative investors can look at short-term funds, said Killol. Aggressive investors with a longer holding period can split their allocation between accrual products and duration products with portfolio duration between 2 and 5 years.
According to Dhawal, tactical investors should consider high quality, liquid investments at the shorter end of the curve. Retail investors should take advantage of the recent increase in yields of quality NBFC & HFC and invest in public bond issues offering attractive coupon rates.
Retail investors should continue to invest at regular intervals, as per their asset allocation and risk appetite, said Bekxy. She feels that investors may invest up to 70% of their portfolio in short term and credit funds while the remaining 30% can be allocated to well-managed dynamic funds.
