Bond funds in India embrace duration as RBI rate cut bets intensify

Bond funds are adding to duration in India as bets that the central bank will keep cutting rates move out on the curve. A second strategy is to rotate to corporate debt ahead of yield compression.

A majority of the seven money managers surveyed by Bloomberg favor the 10-15 year part of the sovereign curve ahead of the Reserve Bank of India’s policy decision on June 6. The preference for duration reflects expectations that the central bank will cut rates beyond the sole 25-basis point reduction being forecast by economists through 2020.

The RBI’s thrust on beefing up cash in the banking system and last week’s thumping election victory for Prime Minister Narendra Modi are also reinforcing the appeal of debt with long maturities for money managers.'

“Rate cuts are very much likely, given there are emerging concerns on growth and projected inflation is fairly within the comfort zone,” said Rajeev Radhakrishnan, head of fixed-income at SBI Funds Management Pvt. “A strong case exists for a rate action” in June, he said.

India isn’t alone in witnessing this divergence between market expectations and economists’ forecasts. As an escalating U.S.-China trade war casts a pall on the global growth outlook, traders in countries such as New Zealand and Australia have been more aggressive in pricing in potential easing by their central banks.

IDFC Asset Management Co. is counting on the RBI to continue injecting liquidity, which along with this year’s two interest-rate cuts has helped soften the blow to the market from the government’s fiscal largesse. Edelweiss Asset Management Ltd. predicts that a breach of the 7.12% technical level could see India’s 10-year yield go as low as 6.65%.

The yield touched 7.12% on Wednesday, the lowest since December 2017. Foreign funds piled $513 million into rupee-denominated debt in the three days following Modi’s win as it put to rest concerns about a diverse group of political parties coming to power.

Here are some key themes and comments from Indian bond fund managers:

More Duration
 

• Principal Asset Management has “added duration via sovereign bonds as the segment is more liquid and quicker to add,” according to Bekxy Kuriakose, head of fixed income
   
• Dhawal Dalal, chief investment officer for fixed income at Edelweiss, is bullish on sovereign debt due in over 10 years
   

Rate Cuts
 

• Pankaj Pathak, a fixed-income manager at Quantum Asset Management Co., said he is expecting a cut in the RBI’s June policy and “maybe one more in August”
   
• Kuriakose of Principal sees a 50% chance of rate cut in June
   

Bonds of State-Run Companies
 

• “At the 10-year point, the AAA state-run companies’ bonds have reasonable relative value still and there is scope for further compression of spread,” said Suyash Choudhary, head of fixed income at IDFC Asset

• Dalal of Edelweiss is also bullish on longer duration high-quality debt of state-run Indian companies. Relative credit spreads between government bonds and AAA state-run companies’ debt in the 10-year segment remain attractive and offer value, despite a sharp reduction in credit spreads for 3- & 5-year AAA bonds, he said

RBI’s Liquidity Support

• “The RBI is implicitly moving the system toward positive liquidity and at some juncture, it will have to come out and emphatically say that,” said Choudhary of IDFC Asset. He expects the RBI’s easing to focus more on liquidity than rates
   
• “The RBI will continue to proactively take steps to ensure liquidity is comfortable,” said Kuriakose of Principal. “Pent up government spending in June may also improve banking system liquidity”

Corporate Debt
 

• Canara Robeco Asset Management Co. “prefers corporates bonds over sovereign notes as the large government issuance in the current fiscal may prevent a sharp drop in yields,” said Avnish Jain, head of fixed income. “Further, corporate spreads are at attractive levels, which may give opportunities to investors to benefit from spread compression as well”