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Investment Insights

Suyash Choudhary

A Summary Of The Year Gone By
 
The year gone by has been a roller coaster for fixed income. Volatility, which has been a word almost missing in other asset classes this year, has been the hallmark for bonds right through. The positive start to the year was soon disrupted with the RBI changing policy stance in February from accommodative to neutral. Bond yields, which were already in the midst of a post demonetization reversal, sold off sharply. The sentiment was accentuated with the minutes of the April RBI policy where one member seemed to even favor a pre-emptive rate hike. Quite ironically, a significant reversal started from this point with CPI collapsing, partly owing to one-off factors. RBI commentary started turning tentative and was ultimately followed with one more rate cut. Simultaneously, concurrent growth indicators appeared to be quite weak with the first quarter GVA print finally triggering a substantial debate over the extent of growth slowdown. Post that one rate cut, however, the RBI remained quite steadfast, focusing commentary on the 4% CPI target. Alongside, an Open Market Operations (OMO) sale program was launched wherein ultimately the RBI issued INR 90,000 crores of bonds to the market. Market appetite for bonds soon got fatigued with excess supply aided by OMOs and with a dwindling risk appetite owing to fiscal uncertainties, rise in global oil prices and continued RBI hawkishness. This started translating into a rapid rise in yields over the final quarter of the year, with risk appetite almost completely breaking down over the last month. The final straw was the finance ministry announcing INR 50,000 crores of extra borrowing for Q4. This was at the pessimistic end of market expectations, especially given the recent assuring noises made around commitment to deficit targets.

 

The Best Bond Trader
 
Most bond traders and fund managers have had a very difficult time over the past few months given the remarkable nature of price movement; almost a one way deterioration with hardly any break or respite. In hindsight, the RBI hasprobably been the best bond trader on the street this year! It has managed to sell INR 90,000 crores from its bond book starting at around 6.5% on the 10 year and ending at around 7%. At the time of writing, the 10 year bond yield is almost at 7.4%. Any market participant who had achieved this feat would have justifiably felt very proud of themselves. Obviously, these comments are made partly in jest. However, some underlying points deserve attention. The central bank and its research had said three things that are of relevance for this subject: One, OMOs will be done non-disruptively. Two, the current excess liquidity is largely non-inflationary absent any substantial multiplier accompanying it. Three, bank lending rates still need to come down. Given these, the persistence with which OMOs were conducted seems a little remarkable. They stopped quite remarkably as well with the RBI preemptively cancelling the last announced OMO partly citing market conditions. However, the real break down in market risk appetite started after this, since the cancellation fuelled hopes that more interventions would happen and they didn’t. Also, from a transmission standpoint, it remains a personal mystery to us how the central bank still expects banks to transmit further when even the front end of the risk free rate has risen sharply over the past few months.

 

Our Thinking Errors Of The Past Few Months     
 
A year end commentary is a good opportunity to also reassess how one went over the year. There are two significant thinking errors that we have committed this year. We started off well after having sold out most of our post demonetization duration positions. The December 2016 policy had amply demonstrated the central bank’s hawkishness and therefore it was no more than a mild surprise to us when the RBI explicitly changed stance in February. Post the yield adjustment in March, we reinitiated a long bias on rates. However, the framework we were operating with from mid-year proved to be flawed. India’s growth had been deteriorating since much before demonetization and despite almost a synchronized recovery in the rest of the world. The after-effects of demonetization only accentuated this trend. Our thesis was that since CPI averages ex of one-offs were now largely around RBI’s targets, the debate may not shift to the appropriate real rate stance that needed to be maintained given the financial stability and growth outlook. The rupee had been consistently strengthening since early year backed by very robust fixed income flows. This was the strongest testimony to the fact that our real rates were very attractive in context of India’s perceived macro-stability status. In fact RBI had quite the task in managing the very strong capital flows that we were seeing. Simultaneously, there was significant deterioration in concurrent growth. Both these seemed to indicate that the time was ripe to re-initiate the real rate debate. Indeed, we were further encouraged in this line of thought when the chief economic advisor expressed similar views in his mid-year economic review; going so far as to flag deflationary forces in the economy. However, as it turned out, the RBI did not express any clear real rate stance, not even a consistent definition on how this is to be measured. Passing references seemed to be adding back the ‘optical’ HRA effect of pay commission that the central bank had previously promised to ignore. Indeed, the focus remained steadfastly on the mid-point of the flexible inflation targeting band of 4+/-2% even as growth projections started to be undershot. Once the October policy showed that our framework was erroneous, we aggressively cut risk in our bond funds.
 
The other thinking error was very recent. We continue to believe that RBI is very far from an actual rate hike. Faithful to this framework, once we judged that the market was moving into rate hike pricing territory, we started deploying cash. With the large scale market break down that has happened over the past month, all tenors of the yield curve have suffered massively. Our stance of zero cash during this period has obviously hurt. However, given the 50 plus bps rate hike pricing that currently exists in front end bonds, we are comfortably carrying forward these positions. To reiterate, the view remains that the RBI is likely on hold notwithstanding further step up in hawkish rhetoric. There are two risks to the view: One, a substantial cyclical recovery in India that closes output gap faster than currently expected. Two, a significant rise in the US dollar that brings financial stability risks back to the fore.

 

The Way Ahead In 2018
 
The best thing starting the new year is that bond valuations seem to be already pricing in a 50 bps rate hike. This is most visible in front end bonds up to 4 – 5 years. Therefore, by definition, the absolute value lies the most in this segment. There are 2 ways to look at this: One, if our view is correct and the RBI is indeed on a long hold then there are substantial mark-to-market gains to be made in this segment. Two, if the view is wrong and there is a further sell off in these bonds, one is still likely to make at least liquid returns from such investments over the year; given the substantial starting spread that these bonds have over money market rates currently. One must also keep in mind that front end rates typically tend to come off over the so-called lean season on credit that runs between April and September. Hence, this looks like a good starting point to invest in ultra short, short, and medium term kind of funds.

 

As far as active duration bond funds are concerned, we are continuing to consider our 2 – 9 year sovereign / quasi / corporate positions as core portfolio. Spreads here are of the order of 120 – 180 bps over repo, again indicative of stress pricing and offer substantial cushion. Longer duration positions have to be treated more tactically. While so far such tactical trades have only lost money given the one way massive spike in yields, it is likely that they deliver better performance over the next few months now that market may be approaching a zone of stability. At any rate investors should continue to consider active duration funds from a longer term perspective. This is imperative since these are not magical funds that can guard against every bout of market volatility. Instead they are run actively around the fund manager’s macro and market framework. The past year has thrown in both errors of framework as well as a bond market sell-off that is almost unprecedented for a country that is not facing any sort of a macro risk whatsoever and is in fact experiencing sub-par growth. Therefore, to look at last year’s returns and decide for the future may prove to be as fruitless an exercise as any other form of rear-view driving.

 

Wishing Everyone A Very Happy New Year

 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The pains of the bond market are well documented and it is not the intent here to go into much detail. However, some points do need mentioning especially in context of this last phase of a veritable collapse in market sentiment:

 
1. The biggest impact, in our view, over the past few months has been owing to excess supply: both realized and anticipated. Thus the realized excess supply was in the form of OMO sale of bonds from RBI to the tune of INR 90,000 crores (approximately 0.5% of GDP). Concurrently, fears with respect to fiscal uncertainties have taken hold with a large part of the market fearing a fiscal slippage and associated extra borrowing. It is to be noted that the OMOs have stopped. Also, while fiscal uncertainties will likely persist for some more time, there have been very reassuring comments from the finance minister on intent to hold the glide path. In fact, and this cannot be fully verified, some media reports even suggested the finance minister expressing intent to hold the 3.2% deficit target. Another report suggested that there are plans to cut spending by INR 30,000 crores and to significantly increase disinvestment proceeds in order to meet the deficit targets. However, bond yields have continued to rise uncontrollably amidst relatively very thin volumes despite these recent positives. Admittedly, global concerns are somewhat larger with US tax plan going through and oil sticky at around USD 65 per barrel. Also the last local CPI print was higher than anticipated. However, the higher external risks so far have been accompanied by a continually strengthening rupee and hence should not unduly affect INR assets. Also, while the recent rise in local CPI is a worry, the unseasonal rise in vegetable prices is already abating and there is some hope with respect to the recent GST rate cuts sobering parts of core CPI. The point here is that the last 20 – 25 bps sell off in bonds amid relatively subdued participation from major market entities seems to be more technical in nature, reflective more of a lack of risk appetite rather than any fundamental trigger.
 

2. The clearest indicator of the stress on the bond curve is not so much from what the 10 year is doing but from what the front end of the curve is doing. As an example, a 2 year government bond is around 75 bps over the repo rate today. Not only is this the highest in recent history, but seems to be indicating upwards of a 50 bps rate hike over its life when compared with the 1 year treasury bill.
 
graph1_2617

 
Source: Reuters: MIBOR: 30 day moving Average; Average Spread: Average of 2yr Gsec/MIBOR from Dec’13 to Dec’17
 

As the graph above shows, the spread of 2 year to average overnight rate is hitting its highest over the past 4 years. It was higher last during the 2013 macro crisis that India had faced.

 

We have highlighted a number of factors earlier as to why we don’t think the RBI will be hiking rates over the foreseeable future. These have included the still existing output gap, a still incipient credit cycle with balance sheet deleveraging still underway, no real and present risks to financial stability, and CPI that is still quite close to the mid-point of the 4+/-2% range when stripped off one-off elements. However, possibly the biggest reason for expecting a long hold is RBI’s commentary itself: The RBI and MPC still insist that commercial banks can further reduce lending rates.  Thus the latest monetary policy statement from December 2017 notes : “ However, the MPC notes that the impact of these factors can be buttressed by reducing the cost of domestic borrowings through improved transmission by banks of past monetary policy changes on outstanding loans”. There are two aspects here :One, a MPC / RBI that still desires lower borrowing costs via better transmission is clearly not contemplating hiking the primary policy rate that signals the direction of banks’ lending rates. Two, such a MPC / RBI should actually be quite worried if the bond market is clearly pricing in more than one rate hike already as denoted by movements in the front end of the rate curve. Admittedly, it is not clear that the RBI is paying enough attention to this phenomenon at least in the near term since there has been no follow through at all since they preemptively cancelled their last announced OMO sale citing in part “recent market developments”. To reiterate, the central bank may feel it has limited role in the long duration part of the curve. We completely agree with this assessment and in fact have found it frustrating at times when RBI’s OMO operations (purchases or sales) have significantly impacted term premiums on the curve. However, it is clearly too much of a stretch to say that the central bank has no role at the front end where forward pricing seems to have already built in rate hikes when the RBI itself still wants lower lending rates.

 

Investor Takeaways

 

The most difficult aspect in the near term is that there seems to be very few fundamental anchors that seem to be defining market price action currently. As we have shown above, it is remarkable that bond valuations are at this level without the country suffering any sort of macro stress. It is doubly remarkable that this is happening when growth is still sub-par and the RBI itself still desires lower lending rates. In a large part the current state of affairs represents a genuine crowding out in the market where RBI’s own OMO bond sales have filled most local risk positions in absence of meaningful offshore participation. It must be clarified that fundamental triggers have also played their part including oil prices and fiscal uncertainties. However, one cannot continually keep discounting every incremental yield rise using the same fundamental triggers; as is sometimes done in general media. The fundamental point remains the same: if one believes RBI’s own commentary one should not expect any sort of a rate hike over the foreseeable future. This remains our base case. The confusion partly is also to do with the continued insistence around the 4% inflation target even with the presence of one-offs including GST and Pay Commission and despite sub-par economic growth and ongoing balance sheet deleveraging. Had there been a slightly broader interpretation of the flexible inflation targeting mandate (only in commentary; one isn’t making the argument here that policy rates should have been cut) in an environment where, given a proactive government, there seems to be little financial stability risks then market participants may have had a clearer  view of the future.

 

The current market phase denotes one of break-down backed by very low risk appetite and market volumes. It is unfortunate that this happens despite our macros being in virtually top order. In our strong view, there is a clear role here for the central banker should it draw even minor parallels from how it approaches the currency market. Specifically, there are two things the central bank should push against, in our view: One, the substantial rate hike pricing as particularly represented by the front end of the curve.  Two, the virtual break down in market risk appetite lately with large institutional players substantially reducing their participation given losses incurred over the past few months.

 

Our own bond portfolios have been significantly hurt, especially over the last 25 odd basis points of sell-off; ironically after the cancellation of the last scheduled OMO sale. This has happened not because we have had a very aggressive stance on duration bonds. Rather, we have chosen not to run cash over this period preferring instead to deploy in bonds up to 5 – 6 years given our view of no rate hikes for the foreseeable future. Bonds in that sector have also sold off aggressively since market participants have chosen to cut risk irrespective. However, so long as our view on RBI policy holds, we are inclined to consider these exposures more from a medium term perspective. There is significant protection here from a 1 year perspective versus running cash. Our longer duration exposures are now largely converted into liquid bonds and we will be more tactical with respect to that part of the portfolio.

 

In our view, investors should focus on the rate hike pricing currently embedded in the curve, and the consequent protection built therein versus money market rates. This is especially true for front end rates largely up to 5 years.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

Introduction

 

The bond market has been a stressful place to be over the past few months. As is well known there has almost been a relentless one way move over this time where, if the 10 year bond is taken as the indicator, yields have risen by around 70 bps. A host of reasons have played their part, and we have discussed these in detail before. These include RBI OMOs, hawkish stance, fiscal worries, and global developments. However, what stands out is that India has been almost singular in this aspect and it isn’t as if this has been a generalized global yield sell-off. This is all the more remarkable since India also is one of the rare large economies that has actually slowed over the past few quarters. Equally noteworthy, the bond market sell-off has actually accelerated lately just as at least one major irritant for market participants, OMO sales, have stopped.

 

There are some recent developments to blame, including some rise in oil owing to a supply disruption and local CPI printing higher than expected. However, bond prices hadn’t been able to even sustain the post policy minor euphoria prior to these events. Given these, and absent more concrete reasons, most of the recent sell off seems purely technical in nature. The underlying environment for some time has been of low risk appetite with even the nationalized bank community, traditionally one of the best stabilizers for bond prices, largely missing in action. In our view, a key contributor to this state of affairs has been the INR 90,000 crores of OMO bond sales that the RBI has done. Absent substantial risk appetite owing to fiscal and external risks, the OMO bond sales have served to fill whatever positions were available to be filled. Indeed, the sense (although unconfirmed) is that many of the banks have been largely absent from recent bond auctions that are conducted for government borrowing. With their statutory limits being cut, RBI supplying bonds, and negative price action causing mark-to-market losses, there is little wonder that appetite for bonds has dwindled.

 

What Now?

 
Given the technical aspects at play, it is extremely difficult to call what causes the current dynamic to turn. Our best estimate is that since most of the current pain has been caused by excess supply of bonds, it is the unwinding of this excess supply that would also lead to the market stabilizing. The first cause for this excess supply, OMO bond sales, is already behind us. The other pending, excess government borrowing, will be known by month end. If this turns out to be nominal, then the stage would be set for the excess supply discount in bond prices today to be unwound.

 

More fundamental, however, one needs to have a durable anchor with which to make sense of the current bond market. The current level of yield is most definitely pricing in at least one rate hike fully. As an example, the 5 year sovereign yield is around 100 bps above the repo rate. This is truly remarkable for an economy that is not facing any sort of financial imbalances or risks. Looked another way, the spread is so attractive that if this 5 year yield were to rise another 25 bps over the course of a year, one will still end up making the repo yield of 6% on this investment. A similar analysis can be done for a variety of trades including, for instance, for the pack of ultra short / short term type of funds versus liquid funds.

 

There is thus just one fundamental point that needs to be debated: will the RBI hike rates in the near foreseeable future? In our view, it is as yet quite premature to start thinking in the direction of hikes. It would be truly remarkable for this to happen at our current level of output and credit growth, consumer sentiment etc. Not just that, by no stretch of the imagination do we have any material risk to our financial stability even with the recent rise in crude prices. Thus the so-called basic balance (current account plus net FDI) is still likely to be only in marginal deficit, real interest rates remain amongst the most attractive despite the recent rise in CPI, the rise in financial savings seems apparent post demonetization, and the RBI is sitting on more than adequate reserves after the forward dollar book is also taken into account. In such a scenario, it is quite unlikely that the central bank will have a non-symmetric reaction function: there was no extra sensitivity to a 100 bps undershoot to the CPI target for almost a year and there is unlikely to be much due to minor over-shoots as well. This is especially true as there seem to be one-offs at play causing inflation today just as there were one-offs causing disinflation then. There have been inflationary consequences of central HRA, GST, as well as the most recent unseasonal rise in vegetable prices. Indeed, it is almost remarkable how the central bank has held on to the 4% goal even in the midst of the policy one offs like pay commission and GST implementation.

 

This said, market uncertainty may endure pending a substantial un-winding of recent inflationary factors. What doesn’t help matters is the infrequent communication from central bank members, as well as the difficulties in understanding their reaction function. As is well known, after having guided the market towards expecting lower real rates late last year, the RBI subsequently chose to run an even higher rate than before for the immediate one year that followed. No concrete explanation was made for this change in view. Then, despite its own assessment that excess liquidity currently is non-inflationary absent an adequate multiplier and an assurance that OMOs will be ‘non disruptive’, it proceeded to over-supply the market with bonds under OMO sale. Most lately, the last announced OMO sale was cancelled presumably owing to market conditions. And yet, there is little follow up action and one even finds ‘bids getting chased’ at government auctions so that there has been a tendency for surprise in parts of the auction tailing. Finally, there is continued insistence that banks should reduce lending rates but no commentary on the persistent increase in underlying market rates that should logically block transmission.

 

The points above are mentioned less as a ‘complain’ but more from the perspective that it has been quite difficult to read RBI’s reaction function. However, we are comfortable concluding for now that the central bank remains on a long hold and that the 4% target should be looked at more from a medium term standpoint. This is also because there are so many volatile items in our CPI basket that it is virtually impossible to ensure the target over near horizons. However, the central bank’s continued insistence on 4% may lead some market participants to believe that there may be a near term action bias on rates when actually there is none.

 

Investor Implications
 
There is too much volatility and noise in the bond market today which will understandably deter investors. Hence, it is important to have one fundamental anchor in place and then assess where the opportunities lie. To us, this today seems to be an overpricing of near term rate hike risks. The most obvious way to ‘fade’ this risk is from ‘front end’ bonds. Given the massive spread over overnight rates and under a reasonable assumption that a meaningful credit cycle is still sometime away, front end rates seem to be offering a lot of protection assuming a long hold from RBI. The obvious products linked to this are in the short term and ultra short term area. However, this is not to say that active duration funds have no significance here. For one, they should be looked at as long term asset allocation vehicles into fixed income. So long as they are actively managed, and the fund manager has a reasonable track record, they have tended to deliver over longer horizons. In these funds, we find the area of absolute value to be the 5 – 9 year segment. We will continue, as before, to play tactical beta via ‘trading’ securities although one must admit that success in that direction has been rather limited lately. From an investors’ standpoint, however, there needn’t be too much focus on these granularities. Ultra short / short term funds versus liquid look attractively priced and well run active duration funds continue to make sense for long term asset allocators.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The RBI kept all rates unchanged in the policy review as was the consensus expectation, while retaining its stance as ‘neutral’. We summarize below the key points from the policy and the media call afterwards:

 
1. GVA forecast has been retained at 6.7% for the full year, despite Q2 printing lower than that projected in the October policy. Thus maintaining 6.7% for the full year,  entails a forecast of 7% and 7.8% for Q3 and Q4 respectively, as mentioned by the RBI team in the media call. In other words, the RBI expects a substantial acceleration over the next 2 quarters to materialize. However, the accompanying commentary is largely tentative on what these growth drivers could turn out to be. Thus Rabi sowing in Q3 has lagged acreage of last year, available high frequency indicators suggest a mixed picture of industrial activity for Q3, while services sector activity has also been mixed in October. The positives quoted include some pick up in credit growth recently which may be aided by recapitalization of PSU banks. Also, RBI’s survey indicates that services and infrastructure sectors are expecting an improvement in demand, financial conditions, and overall business situation in Q4. Nevertheless, the growth drivers that RBI describes seem more long term.  They include increased capital raising from capital markets being deployed in new projects, improvement in ease of doing business rankings, the NPA and balance sheet resolution mechanisms and associated PSU bank recapitalization etc. Importantly, the MPC notes that the impact of these factors can be buttressed through still improving transmission from banks.
 
2. On inflation, the trajectory till March has been raised by a notional 10 bps to 4.3 – 4.7%, despite a multitude of current and evolving risk factors. RBI’s household survey showed inflation expectations firming up for 3 month and 1 year ahead. Farm and industrial raw material costs rose in October. Firms in the central bank’s survey expect to pass through increase in their input prices. Wage growth in organized sector has edged up but rural wages have weakened , particularly in agriculture. Going forward, there is concern that the upward trajectory in core CPI will continue. While the central HRA effect will peak in December, that from states’ implementation may push up housing inflation further in 2018; with attendant second order effects. The rise in oil prices is also a point of concern. On the flip side, the recent rise in vegetable prices is expected to moderate and some retail prices should fall with GST rates having been rationalized recently. The standard risks around fiscal slippages and from global financial instability find mention as well.
 
A key summary from the policy is the assessment: “keeping in mind the output gap dynamics, the MPC decided to continue with the neutral stance and watch the incoming data carefully”.

 

Takeaways:

 

The bond market had gone into the policy with a very low bar for not getting disappointed. This bar has been largely met by the RBI, to the market’s relief. The RBI seems to have an optimistic H2 growth target despite not identifying very meaningful near term triggers that can attain this.  This point is important since if concurrent incoming information proves this forecast to be too optimistic, it may cause the central bank to revise their full year GVA assessment. This would then possibly also imply that output gap is going to persist for longer than currently envisaged by RBI. At any rate, the Governor seemed to indicate in the conference call that they will watch incoming information for a quarter or two; thereby implying a long hold. This is important because the market was beginning to price in some chance of a rate hike over the foreseeable future. There is every reason to push this back. A very large reason also is that the central bank still wants further transmission into lending rates. This, then, doesn’t look like a policy maker who is considering any sort of a rate hike over its own near forecast horizon.

 

On our part, we think that that the RBI is likely to be on a very long hold (as long as one can forecast right now). There is one further piece to the puzzle that remains: we will get the Q4 borrowing calendar at end of December. If this turns out to be not very much higher than the current indicated one, it may lead to some unwinding of the supply discount built on the yield curve currently. This is especially true since the RBI seems largely done with OMO sale of bonds. With a long status quo from RBI and hopefully some bond supply pressure unwinding, the bond market may see some much needed relief over the next few months. The one caveat to this view will be from international factors. However, those seem quite well behaved so far with hopes of oil stabilizing and the US yield curve continuing to flatten despite a tax plan now much closer to getting implemented.

 

Disclaimer:
 

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 

The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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