The RBI's MPC meet yesterday culminated into the widely anticipated rate cut of 25 bps in the Repo Rate to a 7-year low of 6 per cent. This move comes on the back of consistently low inflation numbers - the June inflation number witnessed a sharp drop to 1.5 per cent.
The bond markets had already been anticipating this move, and so yields more or less remained unchanged. G-sec yields eased slightly (around 4 bps) in the short end from their 1st August close, while firming up in the medium to long term maturities.
Importantly, the MPC appeared to be ambivalent about future trends that could go on to influence the all-important inflation figure. It recognized that the gradual tapering of QE by the ECB, coupled with policy normalization by the US Federal Reserve could pose short term risks for Indian bond markets. At the same time, controlled inflation and fiscal deficits and a more or less stable currency signal an improving macro situation, which augurs well for the bond markets. These 'push and pull' factors have prompted the RBI to signal that they will be adopting a 'wait and watch, neutral stance in the medium term.
What this essentially means is that we could now witness a fairly long pause before the next rate cut, which will depend largely upon incoming data prints. Only if inflation remains consistently low at the 3.5-4 per cent mark for the next two to three quarters, is the MPC likely to consider another cut in rates.
Given all of the above, it is quite likely that the benchmark 10-year G-Sec yield will trade in a narrow band of 6.25 per cent to 6.50 per cent in the medium term, offering little scope for debt fund investors to earn capital gains.
It is also likely that home loans will get cheaper by another 25 bps in the next MCLR linked reset cycle, but this should not necessary send prospective home buyers scampering for their chequebooks. One needs to consider their financial priorities carefully before locking themselves into a long-term commitment such as a home loan right now.
Debt Fund investors who are deploying fresh moneys right now should consider funds that balance higher yields with fairly good credit profiles. Corporate Bond funds seem to be a good bet, while longer term GILT funds may be exited right now if tax efficiency permits.
Overall, we can expect range bound yields in the medium term, coupled with a small reduction in home loan rates. Deposit rates may fall slightly as well. In the short term, our bond markets will be keeping a close eye on inflation trends and monetary policy moves in the US and EU.