Debt Outlook July 2023: Exploring the global interest rate environment

The rising inflation and corresponding hike in interest rates have been a concern globally. Now that the US Federal Bank has paused the interest rate hikes, what seems to be in store for the fixed-income markets and likely trends in interest rates for the world, including India? Mr. Deepak Agrawal, CIO-- Debt & Head Products at Kotak Mahindra Asset Management Company Limited highlights the significant features for investors in this month's debt outlook. 

Global Interest Rate Environment:

• In the US CPI inflation for May 2023 was 4%, however, core CPI inflation was higher at 5.30%.
• Post-July 2023, lower inflation readings may result in the Federal Bank staying on hold for the rest of the current calendar year. 
•  Federal Bank can be expected to "Pivot" towards the end of the year or early next year. 
• The 10-year US yields jumped from 3.65% to 3.87% in June 2023.
• Bank of Canada, European Commercial Bank, and Reserve Bank of Australia have raised rates by 25 bps each in June 2023. 
• Bank of England raised rates by 50 bps, higher than the market expectation. 
• The forward guidance of these central bankers seems to indicate the further likelihood of monetary tightening to control Inflation.
• China's central bank lowered a short-term lending rate for the first time in 10 months to help restore market confidence and prepare for post-pandemic recovery.

Trends on the domestic front: 

• India seems to be placed well, with RBI estimates for Inflation pegged at 5.22% and GDP at 6.5% for fiscal 2023-24 (FY'24). 
• RBI kept rates unchanged and maintained the "withdrawal of accommodation”, as a monetary policy stance, in its policy meeting in June 2023. 
• Inflation for May 2023 came in at 4.25%. Barring El-Nino risk, inflation may likely undershoot the RBI inflation forecast of 5.22% for FY 24.
• At a 6.5% repo rate, based on FY'24 inflation projection, real policy rates are in the band of 1.25-1.50%. 
• RBI may stay on hold for the rest of this calendar year, despite narrowing interest rate differential with the US Fed Fund rate. 
• RBI could change its monetary policy stance to neutral in the fourth quarter of the current calendar year 2023 and there can be monetary easing in the first half of next year.

Key highlights on the Bond Yield Curve:

• The yield curve is flat with 1-year – 10-year government securities trading within the 6.90-7.10% band.
• The yield may trade in a narrow range in the near term and then a parallel downward shift as the expectation of Fed "Pivot" and RBI’s "change in monetary policy stance" seems to increase over the next 3-6 months.
•  The yield curve might steep once RBI starts cutting rates. 

Investment strategy: 

Given that rates have peaked and could trend lower over the course of the next six months to 1 year, Investors may consider exploring Long-duration funds, Dynamic bond funds, Banking and PSU funds, or Medium-duration Funds.

Source: KMAMC Internal Research

Disclaimer:

The document includes statements/opinions which contain words or phrases such as "will", "believe", "expect" and similar expressions or variations of such expressions, that are forward looking statements. Actual results may differ materially from those suggested by the forward looking statements due to risk or uncertainties associated with the statements mentioned