Bond rally: Too good to last? - Views on News from Equitymaster

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Bond rally: Too good to last?

Nov 30, 2001

The cheap money policy being pursued by the Reserve Bank of India (RBI) has seen bonds/gilt (government securities) yields falling dramatically (i.e. bond prices are moving upwards). Over the last few weeks, government securities (gsecs/gilts) have been witnessing a very robust rally. Maybe a little too robust, for RBI's comfort. The RBIs Rs 65 bn gilt offering of 3 different maturities (11.50% 2011, 11.43% 2015, 10.18% 2026) had sucking the liquidity off the system as one of its objectives. Market sources believe that the RBI was trying to test the waters with varying paper of maturities and also apply the brakes in the over-heated gilt markets.

Will there be a correction?
GILT FUNDSNAV (Rs)1-MTH6-MTH1-YRINCEP
TEMPLETON GSEC G 16.1 7.2%17.7%34.3%21.6%
BIRLA GILT LT G 15.2 6.7%17.1%33.2%21.6%
DSP ML GSEC A G 15.3 7.0%17.0%32.8%21.4%
PRU ICICI GILT IG 15.1 6.3%16.2%30.1%19.6%
ZURICH SOV GILT PT G 13.1 4.9%15.1%25.9%16.3%
ALLIANCE GSEC LT G 1,347.3 3.6%12.9%21.4%15.7%
Returns over 12 months are annualised

Market sources believe that the current rally in gilt prices is unsustainable and at some point the RBI may intervene to cool it down a bit.

Investors in gilt/bond funds need to get realistic too. All good things must come to end, and the runup in bond prices is a little too good to last.

There are several factors (global and domestic) that could go against the current situation. For one, oil prices could firm up in case the war in Afghanistan were to escalate. Also, with excess liquidity in the system, and a likely pick up in agriculturally led economic growth, a change of stance by the Reserve Bank of India towards its easy money policy cannot be ruled out. Inflation is low right now, but there is no reason to believe that its going to remain that way.

Fresh investors in gilt/bond prices should wait a little for the correction that is likely to happen over the next month or so and then enter these funds. Existing investors have seen a sharp appreciation in the value of their investments in recent months. It may now make sense to book a part of the profits.

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