In an interaction with Vinay Pai, Head of Fixed Income at Equirus

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In an interaction with Vinay Pai, Head of Fixed Income at Equirus

2022 was a year of the unexpected with one shock leading to the other, 2023 is expected to be a year of hope and the year of the return of stability, believes Vinay Pai, Head-Fixed Income, Equirus.

With high levels of inflation cooling off, what kind of impact do you visualise in the bond markets and the yield curve in the short to medium term? 

RBI has raised over 225 bps since May 2022, taking the repo rate to 6.25 per cent from 4 per cent. If we include the reverse repo/SDF, the rise in rates is even higher up to 265 bp. The increase was to rein in inflation which had risen above the tolerance band of 2-6 per cent. The increase was largely led by food and fuel inflation with the core also inching upwards, but gradually. Food inflation has cooled since then and fuel inflation is also stable. The under-recoveries of the OMC had kept the fuel prices elevated and with a lowering of global crude prices, we can expect OMCs to recover the losses which could further help in taming the inflation with potential price cuts.  

With Inflation below 6 per cent and expected to stay within the tolerance band, India is better positioned amongst the emerging nations and developed nations. Notably, the US is committed to an inflation rate target of 2 per cent. Despite several indicators like retail sales, and housing stats showing demand slowdown, employment figures are yet to show the same. Therefore, US rates are in a tricky situation where the balance of demand, employment and inflation suggests that the US will slow down their pace of rate hikes, maybe 25 or 50 bps but will pause longer. 

2022 was a year of the unexpected with one shock leading to the other. 2023 is expected to be a year of hope and the year of the return of stability. A year where uncertainty is expected to fade (but may not disappear). With no more global surprises to come, and with an expectation of a pause from RBI we can expect India’s rate action trajectory to have peaked. However, with rates the factors viz. supply, liquidity and credit growth can have a different outcome. Liquidity is expected to be tight; the supply of bonds (especially in the longer duration segment) will remain heavy led by government borrowing (and fiscal deficit). Credit growth will continue to be closer to nominal GDP growth of 10-12 per cent. All of this translates into a rise in yields, especially long tenure. The offsetting factors will be RBI’s Open Market Operations (in 2nd half of the fiscal), potential for bond inclusion (External), return of FPI flows in the debt market (again later in the fiscal as US rate cuts begin) and domestic growth and savings which brings inflows into insurance and pension funds and positive momentum on yields.

In summary, we could expect short-term rates to remain range bound in the near term with an impact on the rise in yields in the longer end. However, heading into the 2nd half, we can expect a range-bound action across the yield curve as demand-supply imbalances even out. 


How will the forthcoming rate hikes by the Federal Reserve and the high likelihood of a recession in the US affect Indian debt markets? Will the high volatility persist in bond markets over the next few months? 

Globally, inflation remains to be a concern with the Ukraine-Russia conflict at the front. There is a return to the cold war between US and Russia with Russia using commodities as a tool and the US using interest rates as a tool to destroy the commodity demand. The trade embargo has divided the world with trade sanctions. Against this backdrop, the US holds strong labour demand, and a financially healthy system which is hinting at a soft landing, while the Europe region may see a recession with its dependence on Russia for its energy needs coupled with its demographic effects. On the contrary, the reopening of China is a positive for world demand. 

Volatility will continue to remain, based on the existing market conditions. Recently we have seen the strength of the greenback getting tested with markets believing that a “slow hike” means a “lesser hike” while the reality may be contrary. Bank of Japan’s stubborn stance in its ultra-loose monetary policy has already come to test with their “quasi hike” of widening the yield range.  

For domestic markets, the upcoming weeks will be floored with budget, Fed and ECB policy actions followed by RBI policy actions and inflation data. With a plethora of actions sinking in the market, we could see some action. In summary, volatility will continue but may be not at the same level as in 2022. The volatility of 2022 was led by the “uncertainty of the unknowns”. This year it will be “uncertainty of the knowns”. 


How can fixed-income instruments such as bonds help investors navigate volatility and stay invested with low risk?

Fixed-income instruments help investors generate steady returns. Bonds are less volatile as compared to other market instruments while a drop in interest rates gives an opportunity for a capital gain, while a rise in interest rate provides an opportunity for reinvestment of coupons at higher rates. If one looks at a hold-to-maturity product, it offers stable returns over the horizon of investment. 

Small investors should begin by participating in the Public Issuance of Bonds of quality Issuers which are traded on an exchange platform with reasonable liquidity, and in the current scenario, investors should try to lock in their investments in bonds with a 3 to 5-year maturity which may provide good interest rate and a probable capital gain realization over the next year. 

The rates are driven by macroeconomic factors like global interest rates, crude oil prices, liquidity, currency, etc, and one needs to keep track of the same. One can always look to their financial advisor to navigate the data. 


Should investors in long Debt Funds and gilt funds stick to their investments during the current rate hike cycle or consider alternatives such as the floating rate or short-duration funds to maximize their returns? 

The yield curve is flattish with the spread between the long-term bonds and short-term bonds narrow in comparison to the last year. This depicts that there are fewer chances of inflation remaining high for a longer period. The curve will correct itself with the shorter-term bonds rally much more than the long-term as the pause cycle sets in with the expectation of a rate cut as the next likely action (perhaps after 1 year). Longer bonds could see some interim pressure with supply pressure in the first half and balancing in the 2nd half of the year. 

Over the next year, with no more surprises, we foresee the market would react to buying more short-term bonds which will rally with the rate cuts expected post-Q2 and perfect it to the normal yield curve. Hence investors would benefit shift from floating rates to short-duration funds to capture the upside in yields.  

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