The February 5th Monetary Policy Review by the RBI was a turning point for recent events. The RBI announced that they would withdraw surplus liquidity of INR 2 trillion from the almost INR 8 trillion system liquidity. Combine this with the realization that there would be more than anticipated borrowing by the government in this financial year, that there would be high borrowings to fund the government’s plans in the next year and you had a recipe for panic.
To be fair, we all knew that we were at the bottom of the rate cycle but the move up was not anticipated for another year at least. The market got spooked earlier than anticipated in spite of the RBI trying hard to convince it otherwise. It is in the interest of the RBI to keep yields low while the market is demanding higher rates. As I write we still do not know who is winning this round, the RBI or the Market. What is clear is that our strategy for incremental bond investment has to change tactically, till the rates settle down. And the inflation trend becomes clear. Generally, the longer maturities get impacted more with such changes, but this time around it was the shorter maturities that were impacted as it was short term rates that had fallen the most due to excessive liquidity.
Our portfolios have managed the current round of volatility pretty well as we were reasonably spread across different maturities in our choice of funds.
The rising bond yields across the world have panicked equity markets too. As bond returns go up, the expected returns on equity also go up. For future returns to improve, the present prices have to fall. This is the simple logic! Projections on USD strength will also undergo a change in the short term. What is happening now is like “Taper Tantrums – Part 2”. Sharp moves in the market will be the order of the day.
The prescription for such times is a good dollop of cash in the portfolio how much ever one will crib about low returns from cash!