There was a joke going around a few years ago that Alan Greenspan (then the U.S. Federal Reserve Chairman) would be remembered more for his phrase making than his monetary policy making. In 2005-06 he coined the term “bond market conundrum” to refer to the decline in U.S. bond yields in the face of Fed-induced increases in money market interest rates and rising U.S inflation.
Now we have Navneet Munot, CIO, SBI Mutual Fund, refer to it in our context of the RBI lowering rates and pumping liquidity as inflation, bank credit and industrial growth fall. “Bond traders like recession and deflation, conditions when bond prices move up. But alas! The widening government deficit is playing spoilsport and interest rates have actually moved up almost 200 bps over the last 2 months,” he says.
Just today, bond yields once again rose ahead of fresh debt supplies this week. Early this morning (March 17), the yield on the 6.05% maturing in 2019 was at 6.48%, above the previous day’s (March 16) close of 6.40%. Munot observes that the “yield curve is in complete disarray with several 'illiquid bonds' offering massive yield pick-ups”.
The market is clearly worried about the large borrowing programme of the government and is not responding to the indications given by RBI. At the beginning of FY 2008-09, we were expected to borrow 100,000 crore. By the end of 2009, government will be borrowing almost Rs 300,000 crore and for next year we are looking to raise Rs 360,000 crore a year, which is almost Rs 1,500 crore per working day. The size of the borrowing programme is unnerving investors.
RBI’s recent rate cuts did not result in lower yields. On the contrary, we have witnessed yields going up. Though the market is moving against the wish of the RBI, the central bank has many tools with which it can effectively get desired results. And there is no doubt that the RBI wants to bring down interest rates.
Munot admits to the chaos but offers some advice: “There is lot of panic and gloom in the bond market. Yields may inch up a bit more but investors with some risk appetite should use that opportunity to move in.”
As of now, there are a number of factors favouring entry into income funds when the 10-year benchmark yield is at 7% levels.
• Globally interest rates are nearing zero…Bank of England - 0.50%, ECB - 1.50%, FED: 0-0.25%, JAPAN: 0%.
• The WPI is expected to decline and become negative between May and September 2009
• Pressure of government’s borrowing programme will ease in the second half of March 2009
• Banks may turn buyers of gilts for year-end valuation. On December 31, 2008, 10 year G-Sec was valued at 5.25%. Today it is at 7% and banks are expected to reduce their mark to market losses as much as possible.
• RBI will take further action on OMOs and may give the rate signals.
Investors can look at entering income plans but should patiently remain invested.