Long End, Market Willing To Buy But At Its Own Price….

The recent events point towards a gradual build-up of pressure at the long end of the curve. The devolvement at the government securities’ auctions is a clear indication of the markets’ fatigue in absorbing long dated papers at sub-6 % yields. It also means that across investor spectrum the feelings towards auctions is more or less the same. A factor worth pondering over is that this situation is developing despite the best possible liquidity conditions in the interbank market. Two things can help improve the situation, but again, on a temporary basis, that is, a rate cut along with a massive liquidity infusion. But this looks less probable.

The liquidity conditions in the interbank market continues to be in surplus and it is this factor alone that is supporting lower rates at the short end of the curve. These conditions have been prevailing for almost a year now, and this has already provided stability to short term expectations. There are expectations of further economic stimulus from the government and the RBI and going by the pattern of the measures announced so far this year, there may be more borrowings from the central government. The estimates of such borrowings differ widely from each other though it may be anything from Rs. 1 Lakh Cars to Rs. 2 Lakh Crs. This may again put pressure on the rates.

Inflation stands elevated above the 6 % mark, more or less on expected lines. The RBI too has already taken cognizance of this fact in its anticipations. But the rate action may be dependent much on the inflation performance or anticipated inflation performance. Moderation in oil prices, and also an improvement in the prices of food articles may help inflation to come down to more acceptable levels.

Many countries are targeting higher inflation at this juncture with the objective of stimulating the economy. This is a worthy cause to pursue. This is what is reflected in the change of stance of the Fed to an average inflation-targeting, which means a tolerance towards a higher price level to help output and employment pick up faster. But this may not be solution in a country like India where chronic inflation has always been eating into the per capita incomes rendering the disposable incomes insufficient. Lower inflation would also be helpful in pushing up the real yields which would make fixed income a bit more attractive compared to the current levels.

Credit risk is one of the things one needs to be diligent on as the probability of its aggravation is very high in the aftermath of the pandemic and the lockdown. Portfolios with a high component of AAA instruments should be preferred. The broad range on the 10 Yr benchmark may be 5.90 % – 6.20 % as things stand at present. A breach of the range would depend on the developments in the coming two weeks. It is always a good principle to stick to higher risk adjusted returns through portfolios with shorter maturity profile and high credit quality composition.

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