The past three years were difficult for the fixed income markets as central banks around the world were hiking interest rates and reducing liquidity to control inflation. Bond yields (interest rates) moved higher, and prices of long-term bonds fell. Most of the bond funds delivered poor returns over this period.
Looking ahead the macro backdrop has changed completely. The outlook for fixed income as an asset class and bond funds in particular look extremely positive. This is supported by several factors, such as:
- Inflation Cooling off: Inflation is trending down across most of the developed and emerging economies. In the US inflation is expected to get closer to the Fed’s 2% goal in 2024. In India too inflation has been coming down and is expected to fall closer to the RBI’s 4% goal by second half of this year.
- Central banks preparing for rate cuts: With inflationary pressures easing, central banks will have room to cut interest rates going forward. The US federal reserve is expected to cut interest rates starting March or May this year. Others like European central banks, the Bank of England etc. might join the fed later this year. The RBI too is expected to cut interest rates in the second half of the year.
- Fiscal consolidation reducing bond supply: After expanding the fiscal deficit (gap between the government’s revenues and expenditures) during Covid-19 pandemic, the government has been on path of fiscal consolidation. The target is set to bring down the fiscal deficit to 4.5% of GDP by FY 2025-26. For FY 2023-24, the fiscal deficit is targeted at 5.9% of GDP. Reduction in fiscal deficit means government’s borrowing requirement will also fall; consequently, there will be lower issuances of government bonds in future compared to the recent years.
On the other hand, demand for bonds from long-term investors like pension funds, provident funds, insurance companies etc. are expected to increase further in coming years due to increasing financialization of household savings. Falling supply and rising demand will likely push bond yields lower and prices higher.
India’s inclusion in global bond indices: India’s inclusion in global bond indices, such as the JP Morgan GBI-EM Index and Bloomberg EM Local Currency Debt Index has opened a new source of demand in the government bond market. Index inclusion is expected to attract USD 25-30 billion of foreign investments into Indian bonds over the next 12 months.
Key Takeaway:
Indian fixed income market outlook is positive for 2024. Bond yields are likely to go down, which in turn will push bond prices higher. Since long term bonds are more sensitive to interest rate movements, long term bonds are expected to perform better than shorter bonds.
This offers an attractive opportunity for long-term investors.
Investor Recommendations:
Considering the compelling case for declining yields in the next 1-2 years, long-term government bonds present an attractive opportunity.
Dynamic Bond Funds, with their flexibility to adapt to changing market conditions, are well-suited to capture this potential. Investors with shorter horizons and lower risk appetites may find stability in liquid funds.
Disclaimer, Statutory Details & Risk Factors:
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