A combination of liquid and money market funds are expected to benefit from the likely increase in interest rates in the coming months, according to a report by asset management company (AMC), Quantum Mutual Fund.
The fund house added that an allocation to short term debt funds and/or dynamic bond funds with low credit, risks should remain as the core fixed income allocation.
The recent bond market selloff in September continued in October. During the month, the 10-year benchmark government bond yield (Gsec) surged 17 basis points from 6.22% on 30 September to 6.39% on 29 October.
Since 20 September, the 10-year government bond yield has moved up by a cumulative 24 basis points. At the shorter end, the impact was even more pronounced as yields on one-three year maturity government bonds jumped by about 35-40 basis points during the same period.
“Much of the selloff can be attributed to two developments, a steep rise in crude oil price and a normalization of liquidity operations by the Reserve Bank of India (RBI),” said Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund.
The crude oil price has been rising for the last two months due to the pickup in global demand and restricted supply by the oil producers’ cartel – the OPEC and Russia. The Brent oil price has jumped by 18% in the last two months and hovering near its 2018 peak of $86/barrel.
If supply is not raised quickly, crude oil prices will remain under pressure which poses a risk for Indian bonds, believes Pathak.
“Although the macro backdrop is unfavorable, valuations at both the short and long end of the curve have improved significantly after the sell-off. We particularly like the three-five year segment of the government bond market which in our opinion, is already pricing much of the liquidity normalization and a start of rate hiking cycle by end of this year. Given the steep bond yield curve, three-five year bonds offer the best roll down potential as well,” said Pathak.
Additionally, at the longer maturity segment, current yield levels look good from a perspective that the terminal repo rate in this cycle may remain much below its pre-pandemic normal level.
“However, we are restricting exposure to the longer segment due to risk from the rising crude oil prices and the absence of assured RBI buying,” the expert added.
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