Trust Mutual Fund favours short-term bonds as inflation risks rise


Indian government and corporate bonds with tenures of up to two years could be more attractive than longer duration debt in the current scenario because of inflation risks, the head of Trust Mutual Fund said on Thursday.

“I think two-year bonds or lower duration than that is the point where the interest rate risk is not high, but the 10-year part of the (yield) curve has the potential to underperform from here on,” said Sandeep Bagla, chief executive officer at Trust Mutual Fund.

“I am not very bullish on longer duration bonds at current levels. The 10-year bond yields are trading at the lower end of the range, and the corporate bond spreads are not very attractive currently.”

Persistently high inflation increases the pressure on the central bank to hike rates more aggressively, leading to a rise in bond yields and losses for bond holders. In a scenario like this, investors tend to gravitate to shorter-term papers.

The yield on the benchmark 6.54% 2032 bond was at 7.25% after falling 26 basis points in July-August, while that on the two-year 6.69% 2024 bond stood at 6.65%, six bps higher in September.

The spread between the yields on the 2-year and the 10-year bond has shrunk to 60 basis points from over 80 basis points at the end of June.

Trust Mutual Fund managed over 10 billion Indian rupees ($125.52 million) of assets as on June 30, according to data from the Association of Mutual Funds in India.

Bagla said the 10-year bond yield has fallen amid growing anticipation of an inclusion of Indian bonds in global indices and expects a move of another 15 to 20 basis points when the news materializes.

“Once the news comes, we could see an immediate move to 6.90%, but that would not be sustainable,” Bagla said, adding that after the initial reaction the focus would again shift to fundamentals like inflation and supply overhang.

India’s headline retail inflation has stayed above the RBI’s upper tolerance range of 6% for eight straight months, and rose to 7% in August.

Inflation in the United States also unexpectedly rose in August, raising prospects of a more aggressive tightening by the Federal Reserve. This could also put pressure on the RBI to follow suit.

“RBI may have some expectation with regards to inflation, but the actual readings could come higher. Wage inflation could turn out to be a major pain point. Even with rate hikes, service inflation may not come down. Services inflation is very unpredictable and difficult to control,” the CEO added.

Bagla expects inflation to surprise markets and beat the RBI forecasts by 50 basis points on the upside in the medium term. The RBI has predicted inflation to average 6.7% in the current financial year. ($1 = 79.6690 Indian rupees) (Reporting by Dharamraj Lalit Dhutia Editing by Saumyadeb Chakrabarty).

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