The last few years perhaps have been the most volatile for financial markets and the global monetary system, starting with the Covid shock in 2020, geopolitical crises in 2022 and the great global inflation wave starting since 2021.

While the turbulence in the global economy may have subsided, we are far from normality. For the bond markets in particular, the last three years have been challenging, with the rising inflation wave seen post Covid (driven by supply disruptions and oil price volatility), and a period of global Central Bank rate hikes.

The fiscal situation also worsened for most countries globally (India at 9.2% and the US at 14.7%, of GDP) as a response mechanism to the Covid slowdown, and countries are still trying to normalize their fiscal deficit levels.

However, after a volatile three years, there is finally a confluence of positive factors which is expected to result in the year 2024 being a good one for the Indian bond market.

Global policy rates have peaked in 2023 and while global central banks remain ‘attentive to inflation risks’, they are now on ‘pause’ mode.

They are now expected to start cutting rates upon getting comfort about sustained lower inflation prints, going forward.We may therefore shortly see a turn in the global monetary cycle, with yields potentially coming down, together with a steepening of the yield curve.The yield curve in India currently is completely flat while the US yield curve is inverted, and as the rate cuts start happening, we may return to a more normal yield curve.

Of course, rate cuts finally depend on the actual inflation trajectory. It can be argued that the high inflation rates seen post-Covid due to supply chain and geopolitical disruptions are behind us and that gradually, the inflation rates will move back towards the Central Bank’s target.

This is the perfect soft-landing scenario which will bring cheer to all asset classes. However, the other side of the argument is that although the super-high inflation rates have come off from their peaks, inflation remains higher than the central banks’ comfort zone.

The last-mile fight against inflation, especially on the food side, may therefore take a longer time to culminate. Hence, it may be difficult to expect aggressive rate cuts by the Central banks.

The recent GDP print for Q3FY24 was also a big positive surprise, at 8.4% versus estimates of 7.3%. Domestic growth thus continues to be robust and as such, RBI may not find any reason to cut policy rates at this point in time.

Markets however expect that the effects of the large policy rate hikes (340 bps rise in operational overnight rate since pandemic times) will happen on a lagged basis and the negative effects on growth and inflation may be visible only in the next financial year FY25.

Thus, markets continue to build in some monetary policy easing in FY25 and anticipating slower growth-inflation dynamics in the times to come. Whether this story will actually play out, only time will tell.

Notwithstanding the rate cut story, another large positive for the Indian bond markets is the inclusion in the JP Morgan global bond index w.e.f. June 2024 which is expected to bring $25-30bn of flows into India.

Foreign inflows have already started since the announcement was made – total ~$9bn inflows and at a monthly pace of $1.5-2bn.

These passive flows have led to a situation of excess demand for G-secs, especially with the government consolidating fiscal deficit to 5.1% of GDP in FY25 and reducing the gross borrowing.

This passive demand for G-secs is expected to add fuel to any bond market rally arising out of Central Bank rate cuts.

Overall, the domestic factors seem much more positive for the bond market than the global situation.

Domestic inflation has already been in a comfortable zone for RBI and the government has also been following a well-defined fiscal consolidation trajectory.

Oil prices are within control and the rupee currency has also been relatively stable. However, the global factors still point towards a mixed picture – with inflation still stickier and struggling to move lower, the global Debt to GDP being much higher than normal and with geopolitical issues arising every now and then.

In this context, RBI might have to wait for much stronger cues to cut the rates and might choose to follow the Fed on monetary policy easing despite positive domestic factors.

If easing happens in 2024, yields will continue to move lower with the bond market front-running the rate-cut cycle.

(The author is CIO, Bharti AXA Life Insurance)


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