Bond Market Mayhem…

In a sign of deepening crisis  for macro , bond markets crumbled last week chasing investors away from supposedly safer assets like income , bond  and gilt funds as yields spiked across maturities ( bond prices have an inverse relationship with yields)  . Rarely has the street seen such a distress selling in bonds . Last two weeks have been anything but normal for the Indian bond market . Understandably , investors are red faced as their bond portfolios join the list of growing money losers with nothing getting spared except probably fixed deposits . 

While the immediate trigger for such an unusual turbulence in bond market came in the form of liquidity tightening measures from RBI , the deeper cause goes beyond these. Sharp slide in rupee has a major part in this mayhem .  What started as market’s skittish reaction to Fed’s noise on QE tapering  ( Quantitative Easing) triggered a sharp slump in Rupee in subsequent weeks leading eventually to these frightening  measures from RBI with a aim to defend rupee at any cost .

As part of these measures , RBI tightened the liquidity noose further with (1) bank-specific limits for LAF ( Liquidity Adjustment Factor) at 0.5% of the banks deposits  and (2) restrictions on banks flexibility to reserve maintenance ( minimum daily CRR i.e. cash reserve ratio) , thereby impacting bank liquidity severely . These measures , while aimed at curbing volatility in rupee , will increase the overnight rate to 10.25% , transmit the yield pressure across the gilts yield curve with an eventual impact on the lending rates in the economy if sustained .

If these measures stay , they have the potential to puncture the turn-around script that has been the main pull  for the long-India investors over last few months , esp. the long FIIs. The story built around macro cycle turn would be in jeopardy if lending rates move up in response to these measures as it would reverse all the gains that have been achieved by the monetary and fiscal actions over last 12 months to engineer the recovery.  Govt. and RBI of course will be hard pressed to not to lose these gains and hence will make every attempt to reverse the recent liquidity measures at the first sight of stability in the currency . 

If the sharp slump in bond market is anything to go by , market is discounting far worse prospects for the interest rates than the RBI or the Govt. would hope for . Yields across the spectrum have spiked over last three weeks with the accompanying crash in bond prices . 10 year yield which was hovering around 7.3% not long ago have spiked to 8.5% level as of now resulting in about 7 to 8%+ fall in the NAV of gilt funds    . The story is not so different  with other income and bond funds . Given that the market is never fairly valued and it has the fancy to over-shoot and under-shoot , the current slump in bond market can be a wonderful opportunity for long-term debt investors .

Same is the case for equity investors as well . The ongoing nervousness in the broader markets emerging from potential scare of rising interest rates can be selectively used as an opportunity to build bottom-up stock-specific long-term portfolio in a phased manner .

Happy Value Investing !!!


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