We Expect Yields to Move Up Gradually On Expectation of Further Rate Increase & Supply Fears

The policy is largely focused on inflation, both emerging and advanced economies due to higher commodity prices and domestic demand pressures.

On the global front, concerns over sovereign debt in the Euro region, medium term debt sustainability issues in US, supply chain disruptions in Japan and higher commodity prices led to some easing of the economic growth rates. The European Central Bank raised rates for the second time in order to fight back inflationary pressures. Emerging economies including China persisted with tightening monetary policy.

Domestic growth rates saw some moderation in the industrial production data. However, inflation numbers remained elevated, with non-food manufacturing inflation at 7.2% as compared to a long term average of 4%. Credit growth remained at 19.5%, higher than the RBI's revised projection at 18%.

The RBI thinks that the economic growth moderation will be limited by buoyancy in the consumption sector, due to increase in real wages. Inflation estimate has been increased to 7% from 6% due to:

Recent increase in fuel prices

Significant increase in minimum support price for agricultural commodities

Higher non-food manufacturing inflation

Uncertainty of increase in administrative prices of coal and fuel

Inflation and growth outlook still remains contingent on oil price, food price inflation emanating from the monsoon, foreign fund flows to fund current account deficit and fiscal deficit. Large fiscal deficit is a key source of demand pressure. The subsidy burden amounting to 1% of GDP is also a factor contributing towards inflation.

Going Forward

The RBI has continued with anti-inflationary policy. As the growth numbers are still sustaining and inflation is still high, the RBI has chosen to aggressively tackle inflation. The monetary policy stance in future will be determined by evolving inflation trajectory, which in turn will be determined by trends in domestic growth and global commodity prices. A change in stance will be motivated by signs of a sustainable downturn in inflation.

The corporate yield curve may flatten due to more rate pressures. We expect yields to move up gradually on expectation of further rate increase and supply fears.

Bond funds and Monthly Income Plans have been lately focusing on building duration selectively. We continue to seek duration at elevated levels post the policy. Short-end funds have maintained higher cash levels ahead of the policy. Thus, they should benefit from higher yields. We continue to believe that we are closer to peak of interest rates in the current cycle.

Source: http://www.adityabirlamoney.com/news/493523/10/22,24/Mutual-Funds-Reports/We-Expect-Yields-to-Move-Up-Gradually-On-Expectation-of-Further-Rate-Increase-Supply-Fears