Wrap up of debt market in 2020
Let’s look at some key events that shaped 2020:
- Global central bank balance sheet expansion
The pandemic and associated global lockdown prompted all major central bankers to follow a similar approach: expand balance sheet by buying assets from the financial system and adequate liquidity ensured lower /negative interest rates
- The collapse and the resurgence of commodities
The year witnessed a unique phenomenon in April as crude oil touched closed at negative prices for the first time in the history of oil prices. While other commodities too fell in the month of April, as the year progressed the entire commodity basket (ferrous, nonferrous, agri) witnessed sharp resurgence prompting fears of elevated inflation
- The receding US dollar
The US dollar measured by the US Dollar index (a basket of 6 major currencies) depreciated sharply by around 7% which led to a surge in the metal and other commodity prices
- The RBI in action: the conventional and the out of box approach
The "whatever it takes" approach of the RBI to stimulate growth defined the overarching narrative of the monetary policy committee. The RBI has never given such a long future facing guidance in its recent history
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 has been an elixir for the global asset markets; a normalization of domestic economy may prompt a gradual withdrawal of liquidity and be potentially harmful for the shorter end of the yield curve.
There is a possibility of the yield curve flattening, credit spreads expanding and the money market rates dropping the reverse repo anchor as we move ahead to a normalization of domestic and global economy.
Your outlook for 2021
Looking ahead – crystal ball gazing
- Assumption of normalcy
A large part of crystal ball gazing rests on a single edifice: Normalization of the domestic and global economy led by successful vaccination
- The bottoming out of interest rates
Interest rates have bottomed out and would move up in the next year. With inflation rearing its ugly head, the probability of inflation getting entrenched remains likely
- Crude Oil – the possible move up
As situation normalizes the next year, the probability of crude moving higher remains a distinct possibility. With a surge in commodity prices well underway, the market may get surprised by a surge in crude prices complicating the conduct of domestic monetary policy
- The RBI –will they; won't they
To clarify upfront, we are not talking of increasing the policy rates. But we think with global commodity prices holding up and the potential of inflation remaining at elevated levels, it would complicate the RBI policy of an accommodative stance through the next financial year and may force it to acknowledge the higher inflation into their policy construct
Which category of funds should MFDs recommend at this juncture?
- Interest rates will gradually rise. We believe that the investors with a shorter investment horizon should continue investments in ultra-short term and low duration funds.
- For a long investment horizon and a suitable risk appetite, a small allocation to credit risk fund merits attention
