US data in February 2024 was mixed – employment data was better than expected while retail inflation (CPI) was higher than predicted. Bets on the start of rate cuts in the US have now been postponed to June-July 2024 as against March-April/May 2024 at the beginning of the year. Markets perhaps need to be cognizant that while the Fed will likely begin to dial back policy restraint at some point this year, the focus needs to be on the pace of easing and the eventual terminal rate in this cycle, rather that the timing of the rate cut.
After a good start to the year in January 2024, bond markets were hoping for the momentum to continue in February. The headline Union Budget presented on 1st February 2024 was cheered by the bond markets – with a lower-than-expected fiscal deficit of 5.1% of GDP and lesser than anticipated gross market borrowings in government bonds (Gsecs) for FY25, bond yields eased across the curve.
At the Monetary Policy Committee (MPC) meeting in February, the Reserve Bank of India (RBI) expectedly kept the policy repo rate unchanged for the sixth meeting in a row. Pockets in the markets which were hoping to see some dovishness in the policy were disappointed as the Central Bank continued with its withdrawal of accommodation stance and reaffirmed the MPC’s focus to bring down inflation to 4.0% on a durable basis. The post policy statement and comments from the Central Bank indicate that a meaningful softening of policy stance and/or policy rate is perhaps a couple of meetings away, but we draw solace from the comments related to liquidity viz. the RBI’s objective to keep the overnight rate around the repo rate and the Central Bank’s commitment to remain nimble and flexible on liquidity management.
Global markets may well be running ahead of Central Bank talk and guidance; however, India’s bond market appears to be in a sweet spot. The Central Government has completed its gross borrowing program in February 2024 and with no further supply in this financial year, bond markets ended the month on a positive note - the benchmark 10-year Gsec eased ~7 bps (100 bps = 1.0%) during the month to 7.08%.
The Jan-Mar quarter seasonally attracts bulky inflows into long term savings products like insurance, pension and provident funds etc. which are bond market supportive. Furthermore, Indian sovereign bonds will be included in a staggered manner from June 2024 in the JP Morgan Emerging Market Government Bond Index (GBI-EM), and this has the potential to attract around USD 25B. of passive investments in the domestic bond market. Considering that active flows typically lead and/or complement passive flows, India could attract nearly USD35B – USD40B. of foreign portfolio investments (FPI) over 2024-2025.
Bonds have consolidated their gains after the sharp run-up in the early February, but we will not be surprised if the 10-year sovereign bond trades ~7.0% in March 2024 and expect it to head further lower in the next fiscal Fy25.
Policy rate cuts by global central banks seem visible over the medium term and duration funds like dynamic bond funds and Banking & PSU debt funds seem well placed to take advantage of an anticipated falling interest rate cycle.