There is an important lesson here: interest rate cycle and currencies are predominantly global in nature and central banks can only delay the process of depreciation (through interventions) but can’t deny it.
There are ways to benefit from the falling rupee and rising bond yields.
Elevated bond yields will increase borrowing costs across the spectrum, which may in turn squeeze profit margins of companies that have high debt levels. Theoretically, rising yields hurt equity investors, as bonds turn attractive from the return point of view.
On the backdrop of spiking bond yields and weakening rupee, investors have to focus on companies with low (or zero) debt, and companies with high export incomes, says Jagannadham Thunuguntla, Senior Vice President and Head of Research, Centrum Wealth Management.
Centrum expects a further spike in Indian bond yields on expectations of rate tightening by the US Fed, and even RBI.
Widening current account deficit (CAD) amid capital outflows is exerting upward pressure on bond yields. Foreign portfolio investors have sold a net of Rs 38,312 crore worth of domestic bonds and equities this year, data from National Securities Depository showed.
A higher fiscal deficit is also leading to a spike in government borrowings, especially when government’s revenue generation has remained sluggish. Rising crude oil prices are putting additional pressure on India’s balance sheet.
When macroeconomic indicators turn weak, bond yields push higher, resulting in a drop in prices. Investors then tend to seek more returns on bonds to compensate for the risks involved.
As bond prices and yields have an inverse relationship, rising bond yields expose long-term debt funds to duration risks.
An investment strategy in a rising bond yield scenario would depend on one’s investment horizon, says Dwijendra Srivastava, Chief Investment Officer for debt at Sundaram Asset Management.
“You should always look at what is your investment need and what asset class will satisfy that. Bonds will carry a duration risk at this point, as near-term volatility could be high. We don’t know how the rupee and CAD will pan out. Also, a number of macro factors are not moving in straight line,” he said.
Those who have short-term horizons should avoid long duration funds or getting into government securities right now. But if one has a longer horizon, 8 per cent or 8.50 levels on 10-year bond should be an attractive level to get in, Srivastava said.
He said rising current account deficit has been pushing bond yields higher, and higher cost of crude oil and gold imports and rising interest in electronic items will continue to keep the CAD at higher levels.
Hardening of bond yields feeds into inflation through input costs, further increasing yield levels and thus creating a vicious cycle. “We recommend ultra short and low duration corporate bond funds,” Sanctum Wealth Management said.
With bond yields heading higher since July last year, investors and asset allocators are going back to the drawing board. They may find debt relatively more attractive than equity in risk-adjusted terms.
Lakshmi Iyer, Chief Investment Officer of Debt and Head of Products, Kotak Mutual Fund in a recent interaction with ETNow said when yields are at elevated levels, strategies like fixed maturity plans do exceedingly well, because investors get the opportunity to lock into these funds for a longer duration. “You are mitigating interest rate risk,” she said.
Iyer, however, said fixed income assets cannot assure returns, but looking at the nature of the curve, if one is investing in a one-year debenture, the yields today are close to 8.5 per cent. Down the credit curve, one can get maybe 9 per cent.
“If you pick up these instruments and choose them from the underlying in the portfolio, those are the kind of returns that one could look forward to,” she said.
A rising yield curve indicates the possibility of an interest rate hike in the near future, whereas a falling yield curve signals an economic slowdown.
Hitesh Agrawal, Head of Retail Research at Religare Securities, advises equity investors to adopt a buy-on-dips approach in the current market.
“Bond yields are indicating that further rate hike is on cards. Broader interest rate trends are also heading higher over next six months. We may see some slowdown in incremental money flows to equities as FMPs get better. Market participants will not mind re-jigging their portfolios. Strengthening of bond yields is negative for equities. We recommend a selective stock approach. We still have a target of over 12,000 for Nifty this year. Fundamentally, there is no sell signal,” he said.