May 2024 can perhaps be described as a month of consolidation for global bond markets. “Good” macro news in the early part of the month came from a “less hawkish” than expected Governor Powell in the post Federal Open Market Committee (FOMC) press conference. This was followed by encouraging month on month US retail inflation data which grew less than expected and a higher than projected weakness in the employment rate. Geopolitical tensions which had significantly risen in the first half of April seem to have subsided in May, but they continue to simmer. Trade protectionism increased with the US imposing sweeping tariffs on Chinese chips, minerals, EVs etc. Furthermore, the US Presidential election due in November, will have far reaching long term geopolitical implications globally.
The US elections seemed a far distance away for India, which was in the middle a seven-phase election over ~45 days. Markets had given a high degree of probability to the continuation of the current dispensation and thereby policy continuity. Indian risk assets performed smartly in May, with the benchmark indices (SENSEX/NIFTY) reaching a new all-time high during the month, while bonds retraced all the losses of previous month (April), with the 10-year Government of India (GOI) bond (Gsec) easing below the psychological 7.0% level intra month – led not only by supportive global data but also underpinned by a potentially fiscal positive higher than expected dividend (INR 2.1 lakh crore) from the Reserve Bank of India (RBI) and the impending staggered inclusion of India sovereign bonds in the JP Morgan local currency emerging market government bond index from June.
The Lok Sabha election result was not as projected by the exit polls, as instead of expectations of the current government to improve upon their 2019 electoral performance, the new government would now be dependent upon regional parties’ support. India has voted for a coalition governance after 10 years, and thus the form of the new cabinet (ministries) and the union budget in July should give future cues to the markets on the new government’s priorities.
The bi-monthly Monetary Policy Review (MPR) meeting followed the Union election results and the RBI expectedly kept both – policy rate and the stance unchanged for the 8th meeting in a row. Though there remains considerable uncertainty on the timing of the US Fed rate cut, RBI Governor’s statement and the press conference thereafter makes us believe that India could chart a monetary policy path different from the US. We now expect the RBI to begin reducing the policy repo rate from 3QFY25 (bar renewed geopolitical stress or supply side disruption) and anticipate a cumulative 50-75 bps (100 bps = 1.0%) of rate cuts in this lower interest rate cycle.
Yields have inched up above 7.0% (10-year GSec) in the aftermath of the Lok Sabha election results, but we continue to remain constructive on duration over the mid/long term. We see the 10-year Gsec trading around 6.75% in the second half of the financial year. Furthermore, pent up government spending post-election results is likely to improve the system liquidity and the short end of the curve is expected to outperform the long end.
History perhaps hints that asset allocation is the key to long term wealth creation. Thus, fixed income investments should be a part of any asset allocation and complement exposure to other asset classes. In the current context, interest rates are at near peak levels, and are expected to decline over the coming year. Thus, bond investments at the current juncture have the potential do realize not only interest income but could also deliver capital gains over the next 12-18 months.