Over the last few days, the
following has been happening:
1. US
data has incrementally weakened sharply. This has led investors to believe that
even though the US Debt ceiling issue has been resolved, the expenditure cuts
that it would entail may push US into another recession.
2. There
is renewed speculation that Eurozone crisis may continue to escalate despite
the recent 2nd Greece bailout package and other stability measures
taken.
Things came pretty much to a head
yesterday. Investors finally capitulated leading to a sharp sell off in
equities and commodities across the world; and corresponding rally in developed
market treasury bonds. Nymex crude has slipped to USD 86 per barrel whereas
US 2 year bond yields touched a new low of 0.26%.
The rub-off has been felt in our
fixed income market across the curve. Yields across the curve are down between
10 – 20 bps. 10 year gsec has fallen to 8.32% at the time of writing from a
peak of 8.47% touched post the surprise rate hike of 50 bps in July.
Given this huge market swing, it
is important to reiterate some of our underlying views. Specifically, investors
may ask views on whether one should enter gilt funds etc. This update is aimed
at answering such queries.
1. The justification for a fall in yields is essentially the
expectation that owing to heightened global uncertainties, RBI may no longer
hike rates. While this may or may not
turn true, it is readily seen that the first and maximum benefit of RBI
stopping rate hikes should by definition happen at the short end of the curve
(1- 3 year corporate). This, if anything, may trigger a steepening of the curve
sooner than anticipated; thereby bringing forward the expected returns from a
short term fund.
2. With
a sharp fall in asset markets and growth slowdown, fiscal risks for the
government if anything will increase. Hence, the likelihood of more gsec supply
rises with slowing growth. Some key points in this regard are as follows:
a.
Recent media reports suggest that food subsidy bill may rise by
INR 35,000 crs (due to procurement bonus on wheat, increase in MSP for paddy,
etc)
b. Despite
recent fall in crude prices, the government is still heaving under-allocated
for provision of fuel subsidy. A critical point to note here is that the spread
between Nymex crude (which market generally tracks) and our crude basket (which
is a blend of Oman-Dubai crude and Brent) has widened from zero at start of
2011 to more than USD 20 now. Hence,
the effect on our crude basket is not as sharp has would be perceived by only
looking at Nymex crude.
c.
As we have been saying for some time, even assuming a 30 – 40 bps rally in gsecs over the next year (NOT that
we expect that to happen), the effective return over the year may turn out to
be very similar to that in a short term fund. Whereas, it can readily be seen
that the duration risk taken in a short tern fund is much lower than that in a
gilt or income fund.
Hence, we reiterate our call that the best product in the current environment remains the short term fund on a risk versus reward basis.
Suyash Choudhary is Head - Fixed Income in IDFC Mutual Fund
