“The three-year to five-year bonds are being preferred and we still do not find duration (long-term bonds) playing any major role in the current investment horizon,” said Pankaj Pathak, fund manager – fixed income at Quantum Mutual Fund.
However, Pathak did not completely rule out longer-term bonds.
“Tactical positions could be active if the 10-year yield hits 7.50%, which would be good to enter the longer duration papers. But not at the current 7.20%-7.30% zone. At these levels, we should dilute our long positions.”
The three-year bond yield was at 7.11% on Thursday, while the five-year yield was at 7.17%, and benchmark 10-year yield was at 7.28%.
Pathak expects yields to remain at these levels, given his prediction that India’s central bank will hike policy rates one more time in February before pausing. And as the terminal repo rate nears, he also expects the yield curve to remain flat.
The Reserve Bank of India hiked the repo rate by 35 basis points to 6.25% on Wednesday, its fifth consecutive increase, and also highlighted inflation concerns, which has led to market expectations of a further 25-bps hike in February.
“With the policy cycle peaking, yield curve flatness will persist, but if we compare the repo rate to five-year bond yields, terms spreads are relatively higher,” said Pathak.
He does not expect the terminal rate to change any time soon.
“The external sector remains a bigger worry and I do not see this situation changing in any material way next year. If we continue to run a current account deficit and the currency continues to remain under pressure, then the RBI will remain at terminal repo rate for a long time.”