Wrap up of debt market in 2020
2020 started on a sombre note for debt markets as the jump in inflation since November 2019 had taken yields higher. The 10-year bond yields started the year @6.50% and climbed to 6.67% before RBI intervention cooled the markets.
Soon, central banks around the world reacted and the US Federal Reserve cut policy rates by 150bps in a matter of weeks to push the FED rate to zero. RBI got into the act by end of March slashing repo rate by 75 bps and reverse repo by 90 bps in an emergency policy meeting. In a series of measures announced through April, RBI further provided liquidity injection through long term repos, CRR cut as well additional rate cut of 40 bps in May policy, again outside the scheduled policy meeting. These measures brought down the 10-year bond yield to 5.75%. While the repo has been reduced by 115 bps, 10Y has moved by about 60bps i.e. from about 6.50% at start of year (1 Jan’20) to around 5.90% currently.
Corporate bonds continued to outperform as huge inflows in high quality funds (like low duration, corporate bond and banking & PSU funds), post credit scare fuelled by Franklin Templeton funds shutdown, led to sharp rally in short end of the curve as well as narrowing of spread over g-secs. The yield curve steepened as liquidity anchored the short term rates while high borrowings prevented any rally in the longer end of the curve. Further inflation came under pressure as a consequence of higher essential goods prices in lockdown, supply chain disruptions as well sharp increase in excise duty on certain items such as fuel. However, the monetary policy committee (MPC) has continued to favour growth over inflation and continued with its accommodative stance, terming high inflation numbers as transitory and expecting it to correct post winter crop arrival. Overall, 10-year AAA corporate papers performed much better (on surplus liquidity) with rates dropping from about 7.66% to 6.64%.
Currently, there is a lot of liquidity in the debt market as many investors have invested in fixed income funds post market rally. Will the trend sustain?
Liquidity is likely to sustain as RBI is committed to support growth in financial year 2021-22. Further action from RBI is likely depend on rollout of vaccine and extent of opening of the economy in 2021, as well inflation trajectory. While inflation is expected to show a down trend from now on, the extent of decline is likely to determine RBI policy measures, if any. Debt funds returns are likely to moderate in near term. It is recommended that investors should look at investment from a 3-5 year horizon.
Your outlook for 2021
2021 is likely to remain extremely volatile across asset classes. News on the new variants of coronavirus / vaccine rollout is likely to drive risk assets. Central banks have indicated that they are likely to remain in accommodative stance. In large economies, rates are either near zero or negative and are expected to remain low for a considerable period of time. Emerging markets may follow a different path as growth is expected to pick up faster in these economies. However, the growth numbers are likely to remain volatile and policy makers are likely to look at concrete signs of sustainable growth trajectory before withdrawing any stimulus. Central banks, including the RBI, are expected to remain in at least a pause mode throughout 2021.
Which category of funds should MFDs recommend at this juncture?
We continue to recommend high credit quality funds like short duration and corporate bond funds, as credit market recovery is still a long way off. Economy remains under stress and banking sector is still facing some asset quality issues.
For investors having higher risk appetite, long duration funds like income, dynamic and gilts also present good opportunities for investment as the yield curve is very steep and is likely to flatten in the medium to long term.
