The month started on an optimistic note as bond markets factored in a rate cut by RBI. As expected, the central bank cut repo rate by 25 bps in April owing to growth concerns. Accordingly, the repo rate now stands at 6%. However, the neutral stance by RBI and tight liquidity conditions resulted in yields rising across the board.
Retail inflation numbers for March were slightly higher at 2.86% compared to the month prior on account of seasonal increase in food prices. The Wholesale Price Index (WPI) too increased on the back of increased food and fuel prices. On a positive note, India Meteorological Department announced the possibility of a normal monsoon.
The government met its fiscal target of 3.4% for FY 2018-19 by rolling over fuel subsidies and holding back expenditure. The government cash position contributed to the tighter liquidity conditions for the better part of the month.
How did funds react?
Funds in the shorter duration brackets performed better than the long-term funds during the month.
We talked with Devang Shah, Deputy Head-Fixed Income, Axis MF, Dhawal Dalal, CIO-Fixed Income, Edelweiss MF, Mahendra Kumar Jajoo-Head-Fixed Income, Mirae Asset MF and Suyash Choudhary, Head-Fixed Income, IDFC MF to understand market triggers in May and their near-term market outlook.
Key triggers for the upcoming month
Market participants will be closely tracking banking liquidity conditions, believes Devang. April saw a sell-off at the shorter end of the curve on the back of tight liquidity. So markets will track government spending and RBI measures to infuse liquidity. Seconding Devang, Mahendra said that markets are looking forward to RBI continuing the open market operations (OMOs) to increase liquidity. Suyash also believes that market participants will closely track the evolving liquidity conditions.
Markets will also look for early monsoon indicators in May to gauge the annual rainfall, according to Mahendra.
Suyash and Dhawal feel that crude oil prices will be another important trigger for markets. Oil prices are hovering around US$ 75 mark. This is a crucial level for India from the point of view of current account deficit and inflation, said Devang. So markets will be wary of further increase in crude prices feel the fund managers.
Election results will also have an impact on market sentiments, said Mahendra. So far, the consensus is on an NDA majority; however, any surprises will affect market sentiments, he feels.
The rupee is also around the 70 levels, so the markets will also track USD-INR movement, said Dhawal.
The fourth quarter GDP will be on the market’s radar, according to Devang. He expects the GDP growth to be around 6.75%.
US economic data is showing some signs of improvement, said Mahendra. Markets will also track US data to understand the likely stance of US Fed according to him.
Outlook
Mahendra expects markets to be range bound in the near term as oil prices will put upward pressure on bond yields while accommodative monetary policy stance by RBI and low inflation will ease the pressure.
Dhawal is constructive about markets as economic slowdown will give room for RBI to cut rates further. Moreover, RBI’s open market operations (OMO) will provide support to bond yields.
Suyash feels that markets are likely to be volatile in the immediate near term on account of tighter liquidity and crude prices. However, the medium term outlook is constructive due to softer growth and inflation numbers and dovish stance by RBI. Consequently, the 10-year g-sec will trade in the 7.25%-7.50% range.
Devang expects yields to soften from current levels once liquidity conditions improve. Overall, he expects 25 to 30 bps fall in yields across the curve over the next 1-3 months if liquidity improves and inflation continues to undershoot RBI targets. We also expect one more rate cut in the next 2-4 months, he added. I believe we won't see a deep rate cut cycle unless we see shock on the growth front.
Which funds would you recommend to your clients?
Suyash feels that AAA short term bond funds look reasonably priced from the risk-reward perspective.
Dhawal feels that investors with a decent risk appetite can look at 10-year high quality corporate PSU bonds. However, they need to exercise caution in terms of credit rating. Investors with low risk appetite can look at ultra-short term and low duration funds.
Mahendra feels that investors can look at short-term bond funds, as the yields are attractive in the 1-3-year space.
According to Devang, investors can look at short term funds investing in AAA and AA papers in the current markets as 1-3-year corporate bonds are offering 1.75% to 2.5% spread over overnight rates. Also with limited rate cycle and improvement in liquidity conditions short bond funds are better from the risk reward perspective.
