Short-term debt funds continue to offer opportunity

Markets were a bit shaken but not stirred, by a 25 basis-point repo rate hike by the RBI, perhaps postponed from about a month ago.

While the 10-year gilt, the rupee and the Nifty all fell immediately after the policy, all of these indicators recovered, reading positively into the policy guidance that stated ‘further policy tightening is not expected at this juncture’.
The 10-year gilt stood at 8.71% pre-policy statement but rose to 8.8% post policy. It later eased a bit to 8.74-8.76% levels.

Target inflation
Despite lower vegetable and fruit inflation, which was keenly watched by RBI in its last meet, CPI inflation was close to double digits at 9.87% in December 2013. High core inflation, as a result of continued price rise in services, was one of the key reasons behind the RBI’s rate hike.

In other words, the RBI chose to act this time, after a wait-approach in its last meet did not provide comfort on the inflation front.

Impact on debt market
Early part of January 2014 saw 10-year gilts easing from 8.85% levels to 8.7 levels, leading to a short rally in long and medium-term gilts funds as well as income funds. Beginning this month, debt funds rallied 1.0-2.7% as a result of gilt yields coming off.

With the current rate hike, debt markets may, once again, become more complacent, awaiting further cues, locally and in international markets.

Opportunity
The current rate hike together with the tight liquidity condition prevailing since mid-December, provides scope for investors to lock in to attractive short-term rates.

Higher recourse to the MSF pipeline by banks, term repos conducted by the RBI and more recent open market purchases, all go to suggest that liquidity conditions remain tight. Also, historically higher demand for liquidity closer to the fiscal year end is likely to keep short-term rates elevated.

Three-month certificates of deposits were at 9.17% (12-month at 9.33%) and 3-month commercial papers at 9.54% (12-month at 9.88%) end last week.

Investors can consider locking into these rates through 1-year plus FMPs if they are conservative. Investing at this juncture would provide double indexation benefits as well. Others, not wanting to lock-in their money can consider short-term debt funds with a similar time frame and enjoy the same indexation benefit.

What to look for
Besides data on inflation, the immediate data points that could keep the market on tenterhooks would be the outcome of the Federal Reserve meet and the currency crisis brewing in some of the emerging nations. The slowdown underway in China may also keep emerging markets wary.

Do await our weekly call tomorrow on which debt funds you could ride on, in the current scenario.