So far, 2022 hasn’t been a great year for bond markets, even in local currency terms, and emerging market debt yields are pretty flat for the year. Can you explain to us why this is the case?
We have witnessed a structural change in monetary policies, runaway inflation is the most dangerous macroeconomic condition, and most western countries, especially the United States and Europe, are facing runaway inflation. Now, regarding the trade-off between growth and inflation, as long as they are within a normal range, you can support one at the expense of the other. But runaway inflation leaves legislators or policy makers no choice but to confront it head on.
In the case of the Federal Reserve, which mainly determines the behavior of central bankers or the behavior of money flows on a global scale, they have been on the path of dealing with inflation or trying to crush it from forehead. In this scenario, they raised rates or tightened monetary policy conditions more than expected. If you expect some tightening to occur and the Federal Reserve to loosen more than that or make rate hikes more than that and the commentary then remains hawkish, there is no consolation for the bond markets. You’ll see interest rates go up, you’ll see a sell-off in the bond markets and that’s what’s happening.
We must also see the extent of the losses. We’re coming out of an extraordinarily low interest rate regime around the world, from that perspective, when you come out of some kind of two-decade low interest rate regime, going into normalization, you’ll see a significant increase or a significant structural change in interest rates and that leads to bloodshed in the bond markets. This is what we see around the world, it is not exclusive to any particular economy; most economies facing inflation see their bond yields rise primarily because central banks tend to act in parallel.
The rupiah made a new low, it broke through the 81 per dollar mark and the RBI tried to stabilize it. How much do you see the INR falling against the stronger dollar and do you see in light of these fixed income products getting more traction going forward? Also, where do you set the RBI rates?
We are likely to see something like a 50 basis point rate hike in September, when the general expectation a month ago was for a terminal rate of around 6%. The repo rate expectation has risen to 6.5% only because you would not like the interest rate differential to decrease, which puts your currency at risk, especially as you are a deficit country.
We will not see a repeat of the tapering era of 2013, we will see RBI moving in the same direction as global central banks using a few interest rates as a shield but not completely. We have a sufficient or decent amount of umbrella in the form of foreign exchange reserves. RBI will first use this more effectively rather than go all out on interest rates as this will take a heavy hit to the local interest rate market.
Now, when it comes to debt funds, yes, it’s simple arithmetic. Existing bond investors or debt market investors will see interim market price losses, but I think with increased accrued liabilities and increased earnings, the bond market or bond market investors on a longer period, medium to long period are for good return. Just that initial period, the next three to six months is going to be a hollow area. The volatility, both in terms of time and in terms of the absolute number of spikes, would be much less in India compared to the rest of the world.