Debt MFs eye big gains from Fed rate cut, see bond yields easing further

Yield on 10-year G-Sec slips to over three-year low of 6.23%

Debt fund managers are expecting sizeable gains from US Fed's rate cut to accrue across bond yield curve, with ten-year bond yields of government securities dipping 12 basis points (bps) on Wednesday, slipping to over three-year low of 6.23 per cent.

"There can be further easing of bond yields as the Reserve Bank of India (RBI) has also given the signal that it is ready to act in order to give a fillip to the economy," said Mahendra Jajoo, head-fixed income, Mirae MF.

Market participants say RBI can also take a cue from US Fed and take rate cuts to mitigate impact of Coronavirus on the domestic economy.

On Wednesday, the US Fed took a 50 bps rate cut amid concerns over the outbreak of Coronavirus slowing down US and global economy. The rate cut sent the US treasury ten-year yield to a lifetime low of 0.99 per cent.

"Our base case is that we will have 25-50 bps rate cut (from RBI) in April. The space for long bonds rally has opened up further," said Maneesh Danghi, chief investment officer - fixed income, Aditya Birla Sun Life MF. 

"Longer dated papers are likely to gain more due to higher sensitivity, but most duration categories should see gains from US Fed cut. Further, bond markets will be pricing in rate cut from RBI, even though rate cut expectations may or may not fructify," said Lakshmi Iyer, CIO-fixed income for Kotak MF.

The RBI has already cut its repo rate by 135 bps since January last year to give boost to the economy.

Fund managers highlight that less than ten-year duration papers will be more attractive.

"The longer-end may struggle once the current momentum fades, also in part due to significantly higher state loan supply expected over the year. This anticipated loan supply makes the 10 year on the AAA corporate curve less attractive," said Suyash Choudhary, head-fixed income, IDFC MF.

Market participants say further upside in gilt funds -- which take exposure to longer dated government securities -- will be limited due to robust gains already pocketed by such funds. In one-year period, long duration funds have gained 17.4 per cent.

Experts say investors can look at duration play in 7-8 year categories.  

"The spread between 4 year to 7-8 year government bonds had widened to almost 80 bps. Subsequent spreads (longer bonds spread over 7-8 year bonds) are still relatively low. This makes the 7-8 year government bonds 'sweet-spot', with strong likelihood of very wide spreads versus shorter-end bonds compressing over coming months," Choudhary added.

The medium-to-long duration category takes exposure to papers with maturities of 4-7 years, whereas long duration funds take exposure to over seven-year papers.

In one-year period, the medium-to-long duration category has given returns of 9.45 per cent.