Bizarre markets, stretched bond yields: Markets await RBI action, Ukraine peace talks for respite: Lakshmi Iyer

By Lakshmi Iyer

We are in the middle of the war between Russia and Ukraine

Global growth prospects could see margin

It was already showing a scar in bond yields

The world eagerly awaits the opening of the jar of peace

Until then, markets could continue to behave bizarrely

The last month was marked by turbulence on the global financial markets. Gold has rallied as bond yields continue to take their toll. We’ve seen US 10-year Treasury yields rise ~60 basis points from 1.90% to 2.50%. Crude oil prices are up ~15% since the outbreak of war. We have seen the Federal Reserve raise interest rates for the first time in over three years to combat the worst US inflation since the 1970s. Current inflation in the US is well above the annual target of 2%. As recently as December last year, markets were pricing in ~3 rate hikes in CY2022. Now we’re staring at ~7 rate hikes for this year – a sharp turnaround in sentiment!

How does India fare here? India is a net importer of crude oil. Therefore, it is only natural that our current account deficit widens as crude oil prices slowly rise. In addition, a falling INR makes the problems worse. In the last month we have seen the INR depreciate ~1% – which is not that drastic. India’s inflation (see CPI) of 6.10% is still not materially off the 4% +/- 2% CPI target we set ourselves. It is therefore less worrying that the Indian 10-year Gsec benchmark has only moved ~8 basis points from 6.76% to 6.84% over the last 4-5 weeks. It’s also important to note that the fiscal 2022 lending program has ended (with the exception of government bonds), which has helped contain rising bond yields

The decisive factor is how things will continue

The answer to that is not very simple. The steps of the RBI in the upcoming MPC are very relevant. Will the MPC make a U-turn after maintaining a dovish undertone until recently? That would be an important area to watch. We are also launching the GoI lending program for fiscal year 2023 starting April 22nd. How well RBI (in the role of merchant banker for GoI) can navigate this mammoth lending program would be a key factor in the future direction of bond yields. Equally important is the resumption of GSAP (gsec Secondary Market Acquisition Program), OT (Operation Twist), etc. to anchor bond yields going forward. In isolation, the upcoming offering is likely to put pressure on Indian government bonds week-on-week and we are likely to see bond yields move north. Small respites due to falling crude oil prices, fading war scenes, etc. can provide bond prices with a temporary respite. As such, we expect ‘yield carry’ to be a dominant source of return for fixed income investors this year.

(Lakshmi Iyer is Chief Investment Officer (Debt) & Head Products at Kotak Mahindra Asset Management Company. The views expressed are the author’s own.)