Short term rates may come down in July

Alok Sahoo

Head of Fixed Income

Baroda Pioneer MF

  • Spread between Repo rate and 6-12 month short term rates, at 150-180 bps, are on the higher side, providing scope for them to come down in July on the back of better liquidity and lower supply
  • 10 yr G Sec yields likely to remain range bound – yields higher than 8% can be considered fair value to lock in with a 3 year view
  • Key risks to track going forward include progress of monsoons, crude and commodity prices and fiscal slippages

WF: 10 yr G Sec yields have risen more than 125 bps within the last 12 months to around 7.85% levels currently, yet markets fear that worse is perhaps ahead. What is your prognosis over the next 12 months and what do you see as the key drivers going forward?

Alok: The rates have moved up in last one year due to concern on higher inflation, fiscal slippages, hike in FED rates, rate hike expectation and improving growth. We believe that the current rate is factoring in the risk due to higher inflation and rate hikes. The spread between the REPO rate and the 10-year government security yield is at a higher level of 160-170 bps. We expect the 10-year yield to trade in a range of 7.75%-8.25% in FY19 and may not spike from this yield level. However, below average monsoon, faster hike in rate by FED, rise in crude and commodity prices remain key risks to the market. Having said that, higher OMO purchase by RBI may soften the yield level.

WF: At what level of yields would you say long bonds are worth locking into with a 3 year horizon?

Alok: We believe that 10-year yield level at higher than 8% is fairly valued and can be bought with a 3 year horizon.

WF: What are the accrual based funds you offer? How are they presently positioned in terms of YTM and average maturity?

Alok: Ultra short duration, Treasury Advantage, Short duration and Credit risk funds are the accrual based funds that are in our product range. The portfolio YTM of these products range between 8% to 9.25%. The Macaulay duration of these funds are in line with the product categorisation limit as defined by SEBI.

WF: Is there anything among the various macro variables moving around now that might present a risk to investors in accrual based funds?

Alok: We believe the accrual based short term funds are well positioned in this interest rate scenario. Tight liquidity condition in the H2 of FY19 may keep the short-term rates higher.

WF: With relentless rise in banking sector NPAs – including some private sector banks, worries are being expressed about credit quality in corporate bond funds. What has been your record of ratings downgrades vs upgrades over the last 18 months? In what way would you seek to provide comfort to distributors about credit quality in this challenging landscape?

Alok: The Banking sector NPAs mess is there in last three years where as Mutual fund industry has faced very few instances of default. This is mainly because Mutual fund industry usually lends to better rated corporates. In last three years we have not faced any default scenario in any of our investments. We believe that more than upgrade v/s downgrade what is important is whether that upgrade/downgrade has led to a credit spread compression. While doing our analysis we analyse the price, yield curve and the credit spreads before undertaking our investment decision. The historical performance is the best indicator to evaluate the performance as all upgrade v/s downgrade would reflect in the performance of the respective funds.

WF: Where do you see the best opportunities today in the fixed income space?

Alok: The ultra-short term and short-term rates are attractively valued at this point of time. The spread between the REPO rate and the 6 to 12 months short term money market rates are at 150-180 which is at a higher level, pricing in rate hikes. We believe that the ultra-short term and short term rates may come down in July with better liquidity and lower supply of money market instruments.

WF: What are the key risks you will watch out for now?

Alok: The key risks to be monitored are the progress of monsoon, crude and commodity prices and fiscal slippages.


The above article only seeks to provide information to the readers and does not in any way seek to solicit or advise readers to invest in any scheme of Baroda Pioneer Mutual Fund. Baroda Pioneer Asset Management Company Ltd./Baroda Pioneer Mutual Fund and/or its sponsors are not liable for any loss or damage caused to any investor due to reliance on the above article. Readers are advised to consult their investment advisers / tax consultants on the implications of investing in mutual funds. Mutual fund investments are subject to market risks, read all scheme related documents before investing.

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