'Bond yields could stay under pressure over the next 6 months'

The recently released minutes of the US Federal Reserve’s meeting, rising crude oil prices and flaring food inflation back home have dented market sentiment. RAJEEV RADHAKRISHNAN, chief investment officer for fixed income at SBI Mutual Fund, tells Puneet Wadhwa in an email interview that in the current scenario, multi-asset allocation funds remain attractive for retail investors as compared to pure debt schemes. Edited excerpts:

Can there be a more coordinated action by global central banks to check bond markets?

The recent increase in treasury yields can be traced to specific developments surrounding the US’ economy, as well as certain technical factors. The increased prospect of the US economy heading to a soft landing, wherein the drop in inflation is accompanied with a relatively modest drop-in economic activity and resilience in the job market is the prime reason. This should obviate any requirements of any immediate policy easing by the Fed.

That apart, there have been other developments such as the increased supply of bonds by the US treasury, as well as prospects of monetary normalisation in Japan, which traditionally has been a large investor in US bonds. Given that the market is adjusting to new macro realities in a broadly non-disruptive manner, there is no such requirement for any coordinated action by central banks.

What is the outlook for yields, say from a 3 - 6-month perspective?

A lower duration and adequate liquidity within portfolios have been the key in times when bond yields are expected to reset higher. Domestic (bond) yields could stay a bit under pressure over the next six months on account of higher domestic consumer price index (CPI) inflation. While the same can be attributed to food prices, it is essential to appreciate that average CPI inflation in FY24 is expected to still remain around 5.4 per cent, and growth is expected to remain fairly resilient over this time. Given the RBI’s policy target of aligning CPI closer to 4 per cent, and more importantly the role of higher and frequent upticks in inflation in shaping expectations, monetary and liquidity policies may have to remain tight.

Do you see an out-of-turn policy response by the Reserve Bank of India (RBI) to tame inflation?

In the near-term, the RBI is quite likely to persist with absorbing excess liquidity. The incremental cash reserve ratio (CRR) is aligned with that preference. At the same time, the risk of additional policy rate hikes is non-trivial. This is in the context of reasonable resilience in economic growth as well as the deviation in anticipated, and realised inflation from the policy target of 4 per cent. The base-case remains that monetary and financial conditions are likely to stay tighter for a while in this scenario.

What is the worst we can see on the rupee?

The rupee could continue to see near term volatility if there is a broader trend towards dollar strength globally. The RBI is likely to continue to modulate large flows in either direction that should broadly maintain the recent trends on the currency. But beyond these technical factors, the INR continues to benefit from the relative macroeconomic stability that has shone through in recent times. A modest appreciation over the coming year is our internal estimate currently.

Are the financial markets penciling in the rise in commodity prices?

Besides food price inflation, development in crude oil prices need also to be monitored. Overall, while the prospects of some of the largest developed markets accomplishing a soft landing have improved, economic outlook in China can keep commodity prices soft. The prospects of monetary easing in China could, hence, keep a floor on commodity prices for a while.

Do you see investors tapping into hybrid schemes more going ahead?

These products continue to remain attractive for debt-oriented investors. Those tolerant of a moderate equity risk exposure have continued to allocate to debt hybrid schemes. Longer-term capital appreciation through a modest equity allocation, and reasonable carry-through high grade debt allocation should compensate for the lack of indexation benefits. Multi-asset allocation funds that retain 35 per cent equity exposure also remain attractive for retail investors, as compared to pure debt schemes.