Bond markets may witness volatility over the next few weeks. Debt portfolios could see notional losses because of this. Portfolios can be protected by sticking to instruments with shorter maturities or by either holding investments until maturity. Fresh investments should be made in a phased manner, taking advantage of market opportunities.
A rate hike seems more likely now than ever before. Inflation is undoubtedly the centre of monetary policy decisions. The upward pressures to inflation (oil prices, disposable income, government policies, etc.) are gaining momentum. Oil prices still loom as an obvious threat. well-distributed monsoon is good for the economy. When growth prospects improve so does disposable income. Minimum Support Prices (MSP) will play a key role in determining the inflation trajectory.
The MSP is the lowest price at which the government purchases crops from farmers. The MSP is set at the beginning of every sowing season and is not based on the actual market rate. It is central to the government’s agriculture policy. The purpose is to encourage crop production, secure farmers’ financial interests, and provide food security. The efficacy of MSPs on these parameters can be debated, but our objective is to explore its effect on bond markets.
A higher MSP obviously means an increase in food prices for end consumers. This automatically means an increase in food inflation. Since the intention is to secure farmers’ interests, we could see a spurt in rural incomes. Discretionary spending moves in tandem with the rise in disposable income. An increase in spending translates to a rise in inflation. The policy could also increase the fiscal deficit.
If inflation rises, the RBI may resort to hiking rates to cool the economy. A wider fiscal deficit may lead to more government borrowings. These factors could cause bond yields to move up and induce volatility in the debt market. Caution is the watchword.