Let’s bond with the Bonds !!!

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The equity markets are at all-time highs – Nifty breached 15300 while Sensex crossed the 52000 mark. The equity markets are being propelled on strong budget response for infrastructure push and structural reforms, calibrated support from RBI to maintain sufficient liquidity in the system along with increased global inflows that have boosted the confidence in the Indian equity markets.

Though this is great news for equity investors and they continue to reap benefits of the high returns, it becomes critical for a prudent investor to not get complacent in such ‘opportune’ times. It is the right time to rejig portfolios and ensure appropriate diversification across asset classes.

The bonds markets or debt funds have performed well in last couple of years as the interest rates were on a downward trajectory. RBI has been slashing the repo rate (currently at 4%) to support the dwindling GDP growth and infuse in the liquidity in the economic system.

However, now as signs of normalcy begin to appear with respect to the pandemic receding, an active vaccination drive, favourable macro-economic indicators, a sharp rebound and sustainability in the GDP growth is expected. And with this, the interest rates are expected to move with an upward bias in months ahead.

Budget 2021 brought in a reality check for the bond markets – the government announced borrowing plans for financial year 2021-22. Even in the recent Monetary Policy Committee meeting, though the rates were kept constant, it was hinted that the interest rate may start moving northwards in the next financial year in view of stable growth, rising inflation.

RBI has also hinted towards orderly normalization of liquidity by phased increase in cash reserve ratio by 100 basis points to 4% by May 2021. This should gradually lift the yields up.

Bond yield Movement

As the global economy enters a new phase of its V-shaped recovery central bankers and policy makers anticipate a faster return to pre-covid GDP path. Emerging markets growth is likely to rebound on the back of both domestic and external tailwinds. Against this backdrop, the chart below depicts the expected movement of inflation and repo rate in the next few quarters.

Inflation expected to pick up

But that does not mean we start parting way with the bond funds. As we expect interest rates to move up gradually (and prices to go down), why should we bond with the bonds? Because it’s a good buying opportunity at dips.

The interest rate movement is cyclical – so the long term investors need not panic – just realign the return expectations for the coming few quarters. Investors may move towards the short term bond funds – as interest rate move up these funds will benefit from the regular churning of the funds with high interest rate papers.

And as the upward interest rate cycle stabilises, the investors can lock-in for high rating (AAA) long term bond funds – by locking in a higher coupon rate. Investors in bond funds need not panic – they must hold on till the investment horizon. New investments in the long term bond investments may be avoided for the time, however, shorter term bond funds should provide the adequate diversification from equities.

This season of love, my dear investors, we must bond with the bonds…for this bond provides more stability and lasts longer!

Best Regards

Dr. Tarunika Jain Agarwal Ph.D.

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