debt market: Are you looking to invest in the debt market? Focus on the ultra-short segment because the risks are numerous

NEW DELHI: In the current environment of ample government bond supply and likely monetary policy tightening, those looking to invest in the sovereign debt market should focus their attention on the ultra-short end of the market. the yield curve, says Dr. Joseph Thomas, Head of Research, Emkay Wealth Management.

“Any move to the long end of the curve or long bonds can be attempted at levels of 7.50% (for the benchmark 10-year bond yield) and higher,” he told ETMarkets. .com.

Debt securities with shorter maturities present a lower risk of mark-to-market losses in the event of a decline in bond prices. Bond prices and yields move in opposite directions.

Among the main upside risks to bond yields highlighted by Thomas are the weekly supply of central government bonds worth Rs 32,000 to Rs 33,000 crore hitting the market through primary auctions and the fact that the Reserve Bank of India may not have much firepower left when it comes to managing the sovereign bond yield curve.

The central government is expected to borrow Rs 14.31 lakh crores through bond sales in the current financial year, a new high.

“The government borrowing scheme, both the central government and the state governments combined, will be in the amount of Rs 24 lakh crore.”

During the first two years of the COVID-19 pandemic, the RBI ensured that the government bond yield curve, which it often referred to as a public good, remained under control using a combination of tools .

These included large-scale liquidity injections through open market bond purchases, including, for the first time ever, a “government securities acquisition programme”.

However, with upside risks on inflation strengthening over the previous calendar year and the US Federal Reserve showing signs of monetary policy tightening, the RBI halted its bond buying program in October 2021.

Moreover, analysts estimate that the central bank should raise interest rates soon in order to curb the surge in headline inflation, which is currently about 1% above the comfort zone of 2 to 6% of the RBI.

Without regular buying support from the RBI, absorbing the government’s massive borrowing program will be a difficult task for investors, especially as the Center has not made any announcements regarding the listing of Indian bonds on international indices. .

“Such a borrowing program cannot go smoothly without disrupting the market in the absence of RBI support,” Thomas said.

“This support typically comes from the RBI’s liquidity enhancement measures, and given surging inflation, the RBI is less likely to aggressively pursue liquidity measures.

Pressure was also mounting on the central bank to act, Thomas said, as the world’s major central banks pledged to reverse ultra-loose pandemic-era monetary policies and raise interest rates. interest.

Emkay Wealth’s head of research warned that not going in the same direction could hurt the rupee and foreign investors’ appetite for Indian assets.

Foreign institutional investors have already posted a fierce selling streak in Indian stocks, unloading more than Rs 1.2 lakh crore of shares so far in 2022, as the prospect of higher US interest rates has lured investors. investors to the largest economy in the world.

These investors net sold Rs 7,950 of Indian debt during the same period.

“We had indicated 7.15% and 7.35% as target levels for the benchmark 10-year gilt. Although the first objective has already been achieved, returns could reach higher levels as we progress through the quarter,” said Thomas.

“The level of borrowing without substantial support from liquidity measures could even experience a breakout of 7.35% and the movement north could be 7.60%. In the event of high fuel and food prices, rates could even be much higher than we anticipated.”

Tana T. Thorsen