Bond yields are rising, but why? Dhawal Dalal of Edelweiss has the answer
What is the reason behind rising bond yields? Is it high crude prices, domestic liquidity situation or RBIs hawkish minutes?
The current situation in the Indian bond market is because the trader sentiment is being weighed down by three distinct factors. First is the sudden hardening of the US bond yields. US bond yields have increased by about 20 bps in the last couple of days and that had profound negative impact on the sentiments of bond market participants.
Secondly, rupee has been underperforming some of its Asian peers. On year to date basis, there is a 7% delta for Indian currencies performance against the dollar vis-à-vis the peers. For example, some of the Asian peers have appreciated by around 4% against the dollar while rupee has depreciated by about 3% against the dollar on year to date basis. This creates a 7% delta which leads to a negative impact on the total return of the foreign institutional investors and they are the net sellers on a year to date basis.
The third reason is the recent increase in the commodity prices, particularly oil, and its negative impact on economic growth and inflation.
These three factors are affecting the bond market sentiment. As a result of which, we have seen reversal in bond yields. The bond market has given up all the gains generated between last week of March and first week of April. Again the benchmark 10-year yields have moved closer to 7.75%.
At what levels do you see the yield over next six months and end of fiscal year?
The current state of yield curve, both the government bond yield curve as well as OIS curve, underlines the fears of possible rate hikes. The OIS curve is pricing in a possibility of three hikes over the next two years. The Indian 10-year government bond yield curve too is exhibiting the prospects of rate hike down the line.
Looking at Reserve Bank of Indias credit policy and their outlook on inflation, unless the bond market participants believe that RBI is likely to change its outlook again in June or August policy, the three rate hikes are a bit on the higher side. The economic condition or prospects of India are not in a position to withstand three hikes going forward.
How are you looking at retail investor sentiment towards the bond markets? What should they be doing when it comes to investing in fixed income?
Based on the recent selloff, there is a lot of value in two to four years segment of government bond yield. The recent cut off on the two-year government bond was at 7.15%. This means that you are getting about 115 bps more against the repo rate. Also you are getting about 7.75% for one year investment, one year down the line in sovereign bond, which is very attractive from investment perspective.
If you take into consideration, three rate hikes down the line, then even the risk reward ratio is clearly skewed in favour of investors as far as government bonds, maturing between two to four years are concerned.
How do you see FII flows in debt in FY19 especially in the light of US hiking interest rates?
The investors will focus more at the short end of the yield curve and that is where the value is. We like the government bond yield curve maturing between one to four years. Similarly, there is value on selective basis in AAA PSU and PFI instruments maturing within one to three years.
Based on the prospects of the further increase down the line in bond yields as highlighted by OIS curve, the investors will be better off considering investments in liquid and high quality instruments.
Do you think RBI would definitely hike rates in FY19 instead of a prolonged pause?
In terms of risk, we are closely watching dollar and dollars value against major currencies because right now the crowded trade in the bond market is short dollar. Based on our understanding of the technical pattern, the dollar is at the bottom of its trading range. Any further hardening of the dollar going forward will put downward pressure on global currencies including Asian currencies.