The Indian bond market has been volatile in recent months. The 10-year Treasury yield fell from 7.45% to 7% due to recent increases in U.S. Treasury yields and oil prices, but has risen again to 7.25-35%. Axis Bank believes that market dynamics are changing from three aspects:
• Basics – Macro image highlighting the case for adding joins.
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• Structure – changes in market demand and supply dynamics and the case for long-term bonds (duration).
• Relative – A historical perspective that emphasizes the advantages of the bond market over other asset classes.
According to Axis Bank, here’s why now is the time to add bonds.
inflation: Headline inflation rate is 5%. Core inflation continues to decline and could fall below 4.5% as commodity prices are likely to remain low due to slowing growth in China and a weak global economy.
growth :India’s GDP growth appears to be peaking and may remain below 6% for the next two years. This is due to less fiscal momentum from governments and a weaker global economy.
Advantageous external position: India’s external position remains comfortable considering the trinity (foreign exchange reserves, balance of payments, and current account deficit). Will China’s loss be India’s gain? – Probably so!
Narrowing interest rate differential between the US and India: To fight the pandemic, the US government has increased spending to unprecedented levels, leading to a widening of the budget deficit (from less than 3% to 8-10%) and a reduction in US Fed balances. led to significant expansion
$1 trillion to $2 trillion sheet and 2.5 years of accommodative monetary policy stance.
The resulting effects of accommodative fiscal and monetary policies over the past three to five years have resulted in strong growth and an inflationary spiral.
Over the past 12 months, the US Federal Reserve has raised interest rates by nearly 500 bps and reduced the US Federal Reserve’s balance sheet from $3 trillion to $1 trillion.
“The narrowing interest rate differential has kept the RBI on edge. However, we do not expect the RBI to raise interest rates unless we see a significant depreciation of the rupee or capital outflows. “Liquidity will continue to be tight for two months. So the bond market has priced in most of the negative factors, the macro theme is positive for bonds, and the interest rate cycle is fundamentally positive. ,” Axis Bank said.
What about bond yields?
“Analyzing the trends over the past seven years, we generally see a structural demand-supply gap of Rs 50,000 to Rs 1,500 crore every year, with supply outstripping demand and that gap being filled by OMO purchases by RBI. be satisfied.
Nevertheless, over the past few years, there has been a growing trend of AUM/flows by real money investors increasing significantly from Rs 55 trillion to Rs 85 trillion. This has helped bridge the huge demand-supply gap despite huge government borrowing plans over the past few years,” the Axis Bank report said.
Increase in capital stock by real money investors
Further, Axis Bank does not expect the number of borrowings to increase significantly as it expects the fiscal deficit to normalize from 6% to 4.5% over the next three years.
“Additionally, the inclusion of Indian government bonds in the JPMorgan Global Index is expected to generate inflows of $25 billion to $30 billion over the next 12 to 18 months, representing more than 20% of total borrowings next year. “The supply and demand dynamics for bonds are favorable. Active bond traders have allocated approximately $5 billion to $10 billion through March 2024, and the There is also a possibility that they will increase their bond assets in preparation for the new inclusion.”
Fixed income has always been seen as an asset class that provides long-term stability, but surprisingly, contrary to opinion, this period of extreme/prolonged interest rate increases;
Why Axis Bank believes 7.25-7.35% over 10 years above IGB is a good time to add bonds to your portfolio
Some macro risks that stand out are rising oil prices, China’s economic recovery, and the possibility that China devalues its currency to attract capital inflows.
