A Signal for Bond Investment Revival

India’s 10-year government bond yields had been on a rollercoaster ride, hitting a nearly 4-month low on January 15, 2024. As the US Federal Reserve started to adopt a dovish stance in Dec, bond yield has been falling since then. The US bond yields plunged to multi-month lows in December following the Fed’s projection of lower interest rates in 2024. G-sec yields in India moved in tandem with the slump in US yields in December.

While fixed-income investors had a tough year in 2023, equity investors were clearly left in a sweet spot as mid-and small-cap stocks rallied.

Despite the RBI not raising the policy rate for most of the year (the last hike was in February 2023), volatility persisted in bond markets, and the result can be seen in the returns of fixed-income instruments.

Let us try to understand how investors should look at fixed-income opportunities going ahead in 2024

1. US Fed Pivot

Investors may expect that bonds will perform well in 2024 due to some changes in the global monetary policies. The US Federal Reserve has been increasing its funds rate to control inflation, which resulted in high yields. However, with recent developments, it is predicted that the Fed will decrease interest rates, which is good news for bond investments. Additionally, the Reserve Bank of India might also follow suit and cut rates in the second half of 2025. The US 10-year treasury yield, which is an important indicator of bond performance, has gone through some ups and downs in the past two years, but it has now near settled at 4 percent as of January 24.

It has been observed that US bond markets are predicting rate cuts of 125 bps in 2024, while the Fed dot plot is estimating 75 bps. The outlook for bonds is positive in both hard and soft-landing scenarios. In case of a recessionary scenario, bonds generally rally in anticipation of rate cuts. And in case of a soft landing, the return to 2% inflation without any profound economic collapse would mark the beginning of a new monetary easing cycle.

The only risk involved is if inflation suddenly starts to rise again, which may force the central bank back into a hiking cycle. However, the uncertainty around inflation might persist amid ongoing wars and supply chain disruptions.

2. RBI’s Monetary Policy and Inflation Trends

The Reserve Bank of India (RBI) aims to maintain CPI inflation at 4% with a range of +/- 2%. However, in December ’23, India’s CPI inflation rose to 5.69%. On the other hand, core CPI inflation, which excludes food and fuel items, reduced to 3.77% in December ’23, a significant drop from the 6.1% level 

observed in February ’23. For FY24, the RBI has projected inflation at 5.4%. 
Source RBI, Fisdom research

Despite the potential risks of a below-normal monsoon and volatile food prices, average headline inflation is expected to decrease in FY25 to 4.5%. The Monetary Policy Committee (MPC) members have expressed their satisfaction with a real rate of around 1.5%. Currently, the repo rate (6.5%) minus one year ahead CPI inflation (4.5%) stands at 2%, which is higher than the RBI’s comfort level of 1.5%. Therefore, there is a possibility of rate cuts of 50 bps, which the RBI might initiate going ahead after analyzing the monsoon trends and fiscal estimates. 

3. Fiscal Math Supporting Lower Rates

While the Reserve Bank of India’s (RBI) policy decisions affect interest rates, demand and supply also have a critical impact on bond yields. The government’s borrowing and fiscal deficit play a significant role in determining these variables. 

The Union budget aims to reduce the central government’s fiscal deficit to 5.9% of GDP for FY24 from 6.4% in the previous fiscal year. In the current fiscal year, the Centre’s fiscal deficit was 50.7% of the budget target in the first eight months, a decrease from the corresponding period in the previous fiscal year. Capital and revenue expenditures are also lower relative to the same period last year. To achieve a fiscal deficit of 4.5% by FY26, the government is adhering to its fiscal consolidation path.

 If the fiscal deficit for FY25 exceeds the expectations, it could result in higher bond supply, lower bond prices, and elevated yields, even if the RBI keeps interest rates unchanged or cuts the repo rate by 25-50 basis points in H2CY25. However, this scenario is unlikely. The government’s gross market borrowing is expected to be between Rs 14-16 lakh crore for FY25, which is similar to the previous fiscal year’s borrowing of Rs 15.4 lakh crore. This is unlikely to put any upward pressure on yields.

4. Inclusion in Bond Index

Starting in June 2024, the inclusion of Indian G-secs in the JP Morgan Government Bond Index was anticipated to positively influence bond yields. Inflows are estimated to be around 16% of net Gsec supply in FY25, with an expected weightage of 0.8% for India in Bloomberg Barclays global bond indices, which can result in an additional inflow of USD 16-20 billion.

Also, inclusion in these indices enhances macroeconomic stability and can boost India’s FX reserves.  Furthermore, with low foreign ownership of Indian bonds, the risk of yield volatility is limited, making it an attractive investment option.

What should investors do in CY24?

The potential for a US rate cut, a stable fiscal environment, and the anticipated inclusion in the bond index set the stage for a promising year for bond markets specifically in the long duration segments. 

Investors can position themselves strategically on G-secs for potential capital gains as well as high coupon payments, by keeping a close eye on critical indicators such as inflation, fiscal Deficit, and the RBI’s monetary policy. Yields on papers with an effective residual maturity of 5 to 7 years appear lucrative. Though rates are closer to peak, reversals might not be expected immediately.

Markets this week

Source: BSE and NSE

• The Indian equity market faced extended losses in the week ending January 25.
• Factors contributing to the downturn included mixed earnings reports from India Inc, a potential delay in the US Fed rate cut, escalating tension in the Middle East, and sustained selling by Foreign Institutional Investors (FIIs).
• Sectoral performance reflected the negative sentiment, with the Nifty Media index experiencing a significant 10 percent decline. The Nifty Realty index also dropped by 4.5 percent, the Nifty Bank index fell 2.6 percent, and the Nifty PSU Bank index was down 2 percent. Conversely, the Nifty Pharma index showed a gain of 1.7 percent.
• Foreign institutional investors (FIIs) played a major role in the market dynamics during the week, selling equities worth Rs 12,194.38 crore. On the flip side, Domestic institutional investors (DIIs) provided some support by purchasing equities worth Rs 9,701.96 crore.
• The cumulative data for January revealed a significant sell-off by FIIs, amounting to equities worth Rs 35,778.08 crore. Meanwhile, DIIs maintained a positive stance, buying equities worth Rs 19,976.66 crore during the same period.

Weekly Leader Board

Source: BSE

Stocks that made the news this week:

• Laurus Labs witnessed a 6 percent decline in its shares during morning trade following the pharmaceutical company’s announcement of its fourth consecutive quarterly decrease in both profit and revenue. In the December quarter of FY24, Laurus Labs reported a substantial 88.5 percent year-on-year decline in profit, amounting to Rs 23.34 crore. The Contract Development and Manufacturing Organisation (CDMO)-synthesis business also experienced a significant on-year fall of 67 percent. Jefferies, maintaining an “underperform” stance on Laurus Labs, revised its target down to Rs 250. The Q3 performance was characterized as an all-around miss, particularly in the Contract Development and Manufacturing Organisation (CDMO) and Active Pharmaceutical Ingredient (API) divisions, according to Jefferies.
• Yes Bank Ltd reported a significant surge in net profit, exceeding fourfold to reach Rs 231.6 crore compared to Rs 51.5 crore a year ago, as disclosed in a statement to stock exchanges on January 27. However, the earnings fell short of analysts’ expectations, coming in at Rs 415.1 crore. The bank’s gross non-performing assets (NPA) remained stable at 2 percent for the quarter ending December 31, with an improvement in net NPA to 0.9 percent. Net interest income (NII) saw a 2.3 percent increase year-on-year, and the operating profit rose by 5.4 percent to Rs 864 crore.
• DLF shares experienced a gain of 3.8 percent in early trade on January 25 following the real estate major’s impressive performance in the quarter ended December 2023. The consolidated net profit exhibited a robust 26.6 percent year-on-year growth, reaching Rs 655.7 crore, attributed to healthy operating margin performance and increased other income. The revenue from operations also saw a positive trend, rising by 1.8 percent on-year to Rs 1,521.3 crore for the quarter. As of 9:20 am, DLF shares were trading at Rs 758.8, marking a 1.53 percent increase on the NSE compared to the previous session’s closing price. DLF achieved a 15-year-high quarterly profit, recorded all-time high pre-sales, and generated Rs 10 billion in free cash flow in the third quarter of the current fiscal year.

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