Bond markets opened the month on a cautious note on the back of ongoing negative trends seen in the domestic currency market, rise in crude oil prices, escalation in trade war rhetoric, and anxiety caused by the delay in announcement on Minimum Support Prices (MSPs).
Initial relief came on 4 July, with central government announcing MSPs for 14 summer crops for the market season beginning October 2018. MSP impact on inflation depends on several factors including production, procurement and prevailing market prices for crops. According to our analysis, the impact will be circa 37bps at current market prices. However, if production levels are high and procurement levels are low, then MSPs will have no impact on inflation. Indeed, a favourable monsoon trend has raised the prospects of limited inflation impact of MSPs, leading to government security (Gsec) yields declining by circa 5bps.
The latest Consumer Price Index (CPI) logged in at a five-month high of 5% in June compared to 4.8% the prior month. However, the market reacted positively as the headline CPI was lower than market consensus due to lower than expected build-up in food inflation. Core CPI accelerated to 6.5% in June from 6.2% a month ago. In the coming months, retail inflation is expected to come down significantly mainly due to base effect in the food component.
An announcement of Open Market Operation (OMO) purchase (17 July) further boosted market sentiment. Consequently, the 10 year benchmark yield on Government of India (GOI) bond touched a two-month low level of 7.75%. This rally in yields was also supported by fall in crude oil prices. Reports indicating Libya’s plans to reopen its ports and hopes of US Administration’s flexibility for waivers from economic sanctions against Iran on a “case-by-case” basis, led to Brent Crude prices falling to a three-month low of circa US$71/barrel. After some intra-month volatility, crude prices closed near the month’s low supported by higher OPEC production, coinciding with end of summer peak demand.
Yields inched up again in the last week of the month as traders lightened their positions ahead of the widely expected rate hike in the monetary policy meeting on 1 August. RBI increased policy repo rate by 25bp to 6.50%, as expected. Policy stance was maintained at “Neutral”. Signs of a prolonged pause in the policy rate and the expansion in real policy rates to RBI’s desired level of 150-175 bps, led to softening in yields to close near the month’s low on the first day of August.
A 13bps rally in yields on the benchmark 10 year GOI bond in June, a flattish spread on AAA-rated 10 year corporate bond, and high yields on the bond book led to a 0.88% gain in the Fund’s Net Asset Value (NAV) in India rupee (INR) terms. INR depreciated by a modest 0.1% against US dollar this month, restricting the NAV gain to 0.78% in US dollar terms. Year-to-date, the Fund’s NAV is up 1.13% in INR terms; but down 5.81% in US dollar terms, dragged by 6.94% INR depreciation against the US dollar.
The Fund had prudently reduced its duration earlier in the year and we have decided to stick to the strategy of prudence given uncertainty in oil markets, risk of trade war (and currency war) escalation and political uncertainty ahead of next year’s general elections in India. The Fund continued to cut duration and sold longer dated GOI bonds while adding shorter maturities.
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