Well, for the latecomers, the 10-year yield is the `Sensex’ of the bond market. Its movement reflects the sentiment in the money market. A higher yield is considered bad news for debt mutual fund investors, especially investors in long-term debt schemes. Bond yields and prices move in opposite directions. When yields move up, prices fall. That means, the NAV of the debt mutual fund scheme falls when the yields of securities go up.
Debt mutual fund managers believe that investors should brace for some more volatility in the coming days, in both short- and long-duration debt funds.
“The yield moving higher has been in response to a combination of factors. Crude prices started rising again in August. Besides, the merchandise trade deficit for July 18 (released in August) climbed to USD 18 bio, being the highest since June 2013. There has also been a relative strengthening of the USD in anticipation of impending rate hikes in the US. All of this has impacted the rupee leading to a sharp depreciation. All of these factors in turn have impacted bond yields,” says Kumaresh Ramakrishnan, Head-Fixed Income, DHFL Pramerica Mutual Fund.
The Indian rupee has been weak since the start of the year. It recently touched an all-time high of Rs 71.97 against the US dollar. Rupee has lost 165 paise in the last six trading sessions. According to market participants, worsening global trading conditions, escalating trade wars and rising global oil prices has caused panic among forex traders.
Another important factor pushing the yields up has been the rebound in the crude oil prices. “We have seen in the last couple of months that the oil prices have gone close to 80 but haven’t convincingly broken above 80. The oil prices have remained range bound, so, I feel that the yields will also remain range bound. We are expecting it to be between 7-8 per cent, which has been the case in the last couple of months. We are at the upper end of this range at this point and I feel that the bond yields should stabilise here,” Mahendra Jajoo, Head-Fixed Income, Mirae Asset.
Elevated bond yields might also lead the Reserve Bank of India to raise rates further. The RBI has already raised rates twice in this financial year. The repo rate stands at 6.50 per cent and the reverse repo rate is at 6.25 per cent as of now. However, fund managers believe that the chances of a rate hike look bleak at this point. “We have seen two back to back rate hikes in June and August. Post these hikes, we were expecting one more before March’19. But we need to wait and watch to see what happens to the incoming inflation numbers in the next few months as a consequence of the falling rupee. If currency pressures continue, which flow through to inflation, we could revise rate hike expectations from one to two before in this financial year,” says Ramakrishnan.
Debt fund managers have been asking investors to invest in short-term schemes. Investing in short-term debt funds and accrual funds has been their mantra for the last one year. “The shorter-duration section does look attractive at this point. While it is possible given the backdrop, that we may see some volatility even in the short end, we would recommend this segment as absolute yield levels have moved up in the past few weeks. Also, accrual funds remain a good bet, with the higher carry, for those who have appetite for slightly higher credit risk,” advises Ramakrishnan.
Mahendra Jajoo believes that even though the short-term looks attractive, the long-term bonds might also do well in the coming time. “At this point, things look pretty challenging for the debt markets. I would suggest long-term investors to split between short-duration and long-term bond funds. The bond funds are not looking attractive as of now basis their past performance, but a similar situation had happened in 2008 and 2013. That time also, the rupee became extremely volatile but, it was followed by the best time for the debt market for next three years,” says Jajoo. He believes that investors should remain invested in their long-term bond funds.