Debt Monthly View for August 2024

The Indian bond market remained relatively stable in August 2024. The 10-year government bond yield remained in a tight range between 6.85% and 6.92% for the entire month and closed the month at 6.86% vs 6.92% in the previous month.

Money market rates too remained relatively stable in August, after a sharp decline in July. The 3-month Treasury bill yield edged up from 6.62% at the end of July to 6.64% at August end. Despite the drop in treasury bill yields, short-term CD/CP rates moved up during the month as yield on AAA PSU CPs rose to about 7.25% vs 7.15% in the previous month.

Liquidity conditions continue to ease:

Banking system liquidity eased during the month as the average daily liquidity surplus increased to Rs 1.5 trillion as against average of Rs 1 trillion surplus in July. This was mainly due to increased government spending during the month.
Core liquidity, which excludes the government cash balance, too remains in surplus of around Rs 3 trillion. We expect the excess liquidity to fade gradually during the second half (of FY25) as cash withdrawals picks up during the festive season.

Global economies and monetary policy expectations:

Amid easing inflation and a weakening labor market, expectations of interest rate cuts from the Federal Reserve led the 10-year U.S. Treasury yields to drop from 4.14% at the end of July 2024 to a low of 3.79% at the start of the month. It closed the month at 3.91% The Fed Chairman Jerome Powell supported the rate cut calls in his Jackson Hole speech as he said - "The upside risks to inflation have diminished. And the downside risks to employment have increased” and “the time has come for policy to adjust".

The US treasury market is now pricing for 3-4 rate cuts in 2024. Fed rate cutting cycle is expected to continue in 2025 as well with fed funds rate falling to 3.0%-3.25% by end of 2025 from current levels of 5.25%-5.50%.

Most of the other major central banks - Bank of England, European central bank, Bank of Canada too are on monetary easing cycle. Meanwhile, Bank of Japan hiked interest rates in July and is expected to hike more in the remainder of 2024.

Overall, the external policy environment has turned favorable for the domestic monetary policy and the bond market.

Positive long-term inflation outlook:

Headline CPI dropped to 3.5% in July from 5.1% in June, largely due to a favorable base effect. Food CPI also moderated to 5.4% in July from 9.4% in June, despite a sequential rise. The Core CPI which excludes the volatile food and fuel prices, stood at 3.4% in July. As the favorable base effect fades by October, the headline CPI inflation will move above 4.5% again.

As of August 27, 2024, cumulative rainfall for the country as a whole was 5.6% above the Long Period Average (LPA), with the sown area 1.9% higher than last year. Sowing of key crops like paddy, pulses, and millets increased, with pulses up by 5.7%. Favorable monsoon and increased sowing are expected to boost Kharif production and ease food prices, potentially bringing inflation closer to the RBI’s 4% target by early next year. The recent decline in crude oil prices will also help in lowering inflation.

Outlook

With key events behind us, the market will switch back to demand supply dynamics in the bond market and emerging inflation trend.

We maintain our positive stance on long-term bonds in view of the structural shift in the demand supply balance and the cyclical turn in inflation and monetary policy globally.

Growing demand for long-term bonds by domestic insurers and pension funds, along with foreign investors’ index-driven inflows, will bolster the bond market. Furthermore, easing monetary policies in advanced economies should aid a downward move in domestic bond yields as well.

In this declining interest rate environment, investors with medium to long investment horizon, should consider dynamic bond funds. These funds can allocate to long-duration bonds while keeping flexibility to adjust portfolio position if market conditions become unfavorable. This adaptability allows investors to remain invested for a longer period.

Investors with a short-term investment horizon and with little desire to take risks, can invest in liquid funds which invest in government securities and do not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.

Source: RBI, MOSPI, Bloomberg

Above article is authored by Quantum.

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