A good chance to enter, lock in higher yields in debt mutual funds

Will they or will they not? By how much and when? Those have been the questions the markets have been searching for an answer to from central banks regarding tapering and rate adjustments for the last few months in the wake of a rising inflation and improving economic scenario. As the major economic powerhouse countries approach critical threshold of vaccination levels considered adequate for herd immunity allowing further opening-up there and as the inflation sustains at elevated levels even as the marginal momentum slows down, possibility of withdrawal of fiscal and monetary support, that kept the very economies afloat during the worst phase of pandemic was causing nervousness in markets in recent times. Between the FOMC meeting in the last week of July to Jackson hole symposium in the last week of August, the market got the clarity that a taper is a real possibility before the last sunset of 2021. Fed also successfully separated a taper from a rate hike. Thus, Fed has been able to smooth land markets into accepting a start of a taper without any of the turbulence and volatility of a similar episode in 2013, popularly referred to as “taper tantrum”. US 10Y yields remained in the tight band of 1.15-1.35 during this phase and actually declined after the symposium speech of fed chairman from the monthly high of 1.35% towards 1.30% afterwards. Emerging market block yields and currencies also improved slightly. While the US has fully vaccinated 53% of its population, Germany has achieved 60% and the UK has achieved 64%. India has already vaccinated at least one dose to 64crs, nearly 50% of the population. Notwithstanding this, Markets remained concerned with a possible slip up in economic momentum as delta variant of virus rampages through unvaccinated population resulting in escalated no of new cases in western hemisphere. For example, in the US, daily new cases have crossed 15 mn mark after hitting a low of just 5,000. On the positive side, that may just be the silver line that may be holding central banks back from a more hawkish policy stance at this stage. As of present, it seems bond markets will remain range bound till there is any fresh development on the policy front. Focus then comes to how India’s domestic monetary policy, which has remained in an ultra-accommodative mode since outbreak of virus, is likely to respond to the commencement of taper by Fed. CPI inflation in India has been hovering close to 6% for almost 18 months, which is the upper end of ‘tolerance band’. One MPC member has strongly argued to immediately reverse the policy stance while another suggests normalizing policy stance gradually in a calibrated manner. Majority of the MPC members at this stage remain strong supporters of continuing the current policy stance. But as one just saw in the case of Fed, in a matter of a few weeks, the narrative took a U turn from not even talking about “talking about taper” to a nearly certain taper. Having said that, India’s macro fundamentals remain largely stable and improving. Inflation projections suggest a moderation in months ahead. Fiscal deficit as a % of target stood at 21.3% for period April-July’21 as compared to 103.1% in corresponding period last year, primarily due to better revenue. Again a closer look at the inflation would suggest that food and fuel items group has been responsible for nearly 50% of the inflation, that would eventually reverse as fresh harvesting hits markets and helped by the high level of buffer stock with government (83 million of cereals, wheat and paddy), which is 11 times more than the mandatory grain reserve limit. The cost of fuel and other commodity prices are also seeing a downward pressure from its high levels. RBI remains doggedly focused on growth revival and guided that inflation may be transitory in nature It has also clearly guided that policy will be primarily and principally determined by domestic macroeconomic conditions. So as long as the impact of fed tapering on markets remains benign, it works for this stance. To the extent that India has a structural current account deficit and dependence on foreign flows, it is likely that gradual steps will be initiated towards normalizing policy in a way without causing disruption in current momentum. The impending risks of a possible third wave and virus mutations necessitate that central banks everywhere including RBI don’t take a hasty step forward. The inflation situation could remain manageable for the next couple of months with recent softness in commodity prices, especially oil. But with growth still at a nascent stage, it may not be time yet for aggressive action.The investors who have long term goals should remain invested and ignore the interim volatility, the current situation may offer a good chance to enter and lock in higher yields for a long period of time. (The writer is the head of fixed income, Mirae Asset Mutual Fund, India)

from Economic Times https://ift.tt/3tDiPfL