test-image

Key announcement:
RBI kept benchmark rates unchanged implying that the repo rate and reverse repo continue to remain at 4% and 3.35% respectively. Stance of RBI monetary policy committee (MPC) continues to remain accommodative.
Assessment of MPC statement:
MPC decided to “stay on hold with regard to the policy rate and remain watchful for a durable reduction in inflation to use the available space to support the revival of the economy.”
Reaffirming the accommodative stance, the MPC stated that “while space for further monetary policy action in support of this stance is available, it is important to use it judiciously and opportunistically to maximize the beneficial effects for underlying economic activity.”
In lines with recent MPC communique, inflation and growth trajectories were reflected by trajectory and not through fan charts and range. MPC expects headline inflation to remain elevated through July – September and moderate through October – March period largely due to favorable base effects. The growth trajectory for FY 2020-21 is expected to remain negative.
Market impact:
Wider wedge between credit (~6%) and deposit (~10%) growth denote that banks continue to face ‘problem of plenty.’ Moratoriums followed by loan restructuring in the backdrop of slow growth prospects indicate that the credit growth will not be in a hurry to improve any time soon.
With not much of surprises above; bond markets reacted to the MPC inaction in a muted manner as yields hardened by 4-7 bps post the announcement. Yield curve has remained fairly steep through the past few months providing further cushion for medium – long end rates to remain immune to outcome of today’s MPC meet. With no change to liquidity conditions and outlook thereof; short end rates continue to remain intact.
Way ahead:
Going ahead, we expect the yield curve to maintain this steepness until RBI comes with next round of measures to address the demand supply. As the supply schedule gets heavier; yields on medium – longer end bonds may reflect incremental hardening.
Dislocation in the corporate bonds and SDL led to doses of stability from RBI via HTM backed TLTRO and measured supply. Government securities would await similar measures to address their demand supply equation. Hence, it’s not matter of ‘if’ but when & what extent of dislocation would entail RBI to announce further measures.
While it may look unusual for yields to bear a muted reaction for no change in rates; it is important to remember that even 40 bps cut in the previous MPC meet witnessed hardly any change in the ten year yields. This denotes that the driver of returns in fixed income have now moved from being rate cut driven to being demand-supply driven.
RBI actions have so far steepened the yield curve considerably narrowing the difference between cash deployment and investment in short term assets. Central bank actions on liquidity and rates have pushed the investor to add one layer of risk to their investment. From fixed income perspective; this additional layer comes in the form of duration or credit.
Sensitivity to credits has certainly improved with HTM enabled TLTRO and sustained super surplus liquidity. That said, steep yield curve and narrow credit spreads imply that medium to long bonds provide more favorable risk-reward opportunity. Herein, to suppress the volatility of marginally higher duration, we recommend to apportion investments between roll down and open ended funds bearing flexibility to maintain higher duration. This will enable to capitalize on flattening of yield curve as and when it happens courtesy RBI measures. An all season bond fund will suit this cause.
Source – Internal
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.