The bond market continues to demonstrate robust performance. Domestically, the recent budget provided definitive evidence of policy continuity and a commitment to fiscal consolidation. Internationally, signs of an economic slowdown have become more pervasive. Combined with more moderate inflation, this has prompted the Federal Reserve to actively consider rate cuts. Meanwhile, China has implemented fresh monetary easing, leading to a sharp decline in bond yields despite the central bank's efforts to stabilise them. The yen has experienced a rapid appreciation in recent days, disrupting global 'carry' trades that used the Japanese currency to fund investments elsewhere. This, along with weak economic data from China, may be contributing to downward pressure on commodity prices, alongside renewed concerns about global freight rates.
In summary, India’s strong structural story is aligning with what appears to be a global tailwind for bonds. Additionally, the Reserve Bank of India’s proposed adjustments to the liquidity coverage ratio (LCR) framework for banks, if implemented, will create significant additional demand for Statutory Liquidity Ratio (SLR) bonds. While bonds, particularly shorter-term ones with higher LCR-related demand, have rallied, market participants still show resistance to fully embracing the market. Specifically, there has been some hesitation among real money entities to overweight 30-year government bonds. Concerns include liquidity in this segment, perceptions of it being a ‘crowded’ trade, the view that the move is overdone, and fears that delisting incremental issues from FAR status will reduce global investor interest. As we remain confident in this trade, we present counterarguments, acknowledging the importance of considering opposing views.
The long end of the curve is no longer as exotic as it was a few years ago. Long-term investors, such as insurance and pension funds, have gained prominence, and bonds with maturities of 30 years and beyond now constitute approximately 35% of annual central government bond issuances. In comparison, 10-year issuance is under 25%, despite being the most liquid part of the curve in secondary market trades. Consequently, liquidity at the longer end has improved. Additionally, most purchases in this segment are made against genuine future liabilities. With the growing presence of investors in this segment, a significant forward rate market has developed, used by insurance companies to secure future payouts. Thus, while there may be considerable narrative noise, it is an exaggeration to call positions in this segment overcrowded since they serve genuine business purposes.
The argument that this market move is overdone warrants further examination. Even if one disagrees with our structural view on Indian bonds, a bullish outlook for the next few years is difficult to contest. Duration is crucial for real money investors, and the 30-year bond offers roughly twice the duration compared to the 10-year bond. Therefore, even if the yield curve steepens during the rally, the 30-year bond is unlikely to underperform the 10-year bond significantly on an absolute basis. This issue is different for trading entities, where risk limits are more restrictive, but it does not apply to real money investors like mutual funds, insurance companies, and pension funds.
Finally, concerns that the exclusion of new 14 and 30-year bonds from FAR status will diminish foreign portfolio investor (FPI) interest seem exaggerated. There are still ample limits in the general quota for FPIs to invest in non-FAR securities. Moreover, FAR bonds have not commanded a significant premium over their non-FAR counterparts. The existing stock of 30-year bonds remains available for FPIs, potentially increasing their value due to limited additional supply.
Our view is that Indian bonds are structurally sound, and we expect the demand-supply equation to increasingly favour demand. The government’s focus on reducing the debt-to-GDP ratio further strengthens this view. Consequently, we remain confident in our overweight position in 30-year government bonds and advise investors with the appropriate risk appetite and investment horizon not to be overly swayed by short-term fluctuations. The risk of distraction is missing the larger picture by focusing too much on immediate details.
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