No ‘Rate Hike’ as a Positive Surprise – What lies ahead

At the first RBI’s bi-monthly monetary policy committee (MPC) meeting of the financial year which concluded on April 06, 2023, a ‘no rate hike’ or pause was announced after 6 consecutive interest rate hikes since May 2022. This came as a positive surprise as the hawkish tone in the February policy statement and surprise jump in Inflation in the last month had fuelled an expectation of a rate hike in this policy. The governor made repeated reference to the potential impact of the effective 290 basis points of rate increases in the last 1 year. They also revised down its inflation forecast for FY24. This indicates that the RBI has probably reached its destination in terms of the level of Repo Rate and will hike rate only if inflation path moves up significantly. The pause also seems to be driven by global financial stability issues.

Some of the Key announcements of this policy meeting

• The policy repo rate left unchanged at 6.5%. Consequently, the SDF (Standing Deposit Facility) rate remained unchanged at 6.25% and MSF (Marginal Standing Facility) rate at 6.75%

• The policy stance retained as ‘withdrawal of accommodation’ to ensure that inflation progressively aligns with the target, while supporting growth.

• The GDP Growth estimate maintained at 6.5% YoY in FY24.

• The CPI inflation estimate for FY24 revised down from 5.3% to 5.2%.

Impact on Bond Markets

The governor made special efforts to sound hawkish by singling out this rate pause as onetime deviation from its broader monetary policy path. Despite the use of Phrases like ‘for this meeting only’ and ‘a pause not pivot’, the bond market seems to have read it differently. Bond yields fell by around 10 basis points post policy announcement with the 10 year government bond yield falling below 7.2%.

Going ahead, the bond market will price for extended rate pause with terminal repo rate at 6.5%. This should open up space for Government bond yields to go down. We would expect the 10-year government bonds to trade between 7.00%-7.40%.

At current yield of 7.2%, government bonds are now offering positive real yield of about 200 basis points based on 4 quarter ahead inflation estimate of 5.2%.

Also, with the rate hiking cycle nearing end and inflation trending down, probability of capital gains in long term bonds has increased. if you have over 2-3 years investment horizon you should allocate to Quantum Dynamic Bond Fund which tends to benefit in this kind of interest rate environment. If you are looking for a shorter holding period and building your emergency corpus, you can stick to Quantum Liquid Fund with good credit quality portfolio.

Diversification is the key

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Above article is authored by Quantum.

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