‘I expect 10-year government bond yields to come down by June’

While the RBI is yet to hike the repo rate, the G-Sec yields have risen sharply in the last six months. what next?

Generally, long-term bond yields tend to outweigh RBI’s policy action as they are a function of evolving macro-economic fundamentals while short-term yields depend more on RBI’s action. In India, there is a clear move in bond yields after RBI discontinued G-SAP in its mid-year policy. RBI is no longer buying government securities and the supply of government securities has also remained stagnant, and hence yields have increased.

As of now, the only driver is RBI as in the absence of its intervention, yields will rise in view of imminent recovery in bond supply and volatility in prices in the commodity basket along with the global environment. Hence, RBI would like to moderate the yield. At this juncture, the RBI’s guidance is clear, focused on growth and confident of moderation in inflation in the next quarter. So, if inflation picks up or global markets become volatile, RBI may have to step in. Until then, the supply of bonds is the factor that puts pressure on yields. We are going to see the start of the lending program for FY23. So, there will be some practical pricing and therefore, I expect the yield to come down to 6.25–6.50% by June.

Which debt funds matter the most to investors today?

There is a lot of volatility right now and since everyone is expecting rates to go up, they are exiting the short-end of the curve. Therefore, the yield curve is steep. So, while rates may rise, the opportunity cost of waiting and not investing is also very high. Now it makes sense to invest in Target Maturity Fund (TMF). Also, if you hold the money for a short period of time, you will be taxed at your income tax rates, whereas with TMF, you get the long-term capital gains tax benefit.

Do floating rate funds really perform better than other funds in rising rate conditions?

If you look at the last six months till March 15, where short-term rates have gone up, most floating rate funds have outperformed liquid funds.

There is limited availability of floating rate bonds in India. When you are using overnight interest rate swaps, you are taking risk on a basis. So, for example, when we hedge, we expect that if corporate bond yields increase by 50 basis points (bps), their price will move in the opposite direction to the same extent. In reality, what can happen is that cash bond rates move up 50 bps but swap rates only move 30 bps.

Also, when you’re buying a bond and swapping against it, you’re getting a fixed rate on the bond and paying a fixed rate on the swap, and getting a floating overnight rate. . Effectively, you are holding an overnight fund.