Time to accumulate bonds and lock-in attractive yields with peak rates around the horizon

• Turmoil in the financial sector, peak rates on the horizon and economic uncertainty make the case for investing in bonds at current yields, according to analysts.
  
• The collapse of Silicon Valley Bank and Signature Bank in the US, and the Credit Suisse saga has raised fears of contagion risk in the financial sector.
  
• These events could force the Federal Open Market Committee to halt its rate hikes for the time being, and thereby also reduce the pressure on the Monetary Policy Committee (MPC) to hike rates in April.
  
• Analysts believe the bond markets have already priced in another rate hike by RBI’s MPC, and the current yields could be a good indicator of future return.
  

Investing in bonds may be boring when compared to equities, but it’s exactly what investors should consider, according to analysts. A combination of factors like the financial sector crisis possibly derailing economic recovery, and peak interest rates on the horizon has led to analysts believing that boring bonds could be better investment options than equities at this point.

“The sentiments in global debt markets have turned from being cautious to attractive due to sudden emergence of events leading to financial instability in the US,” said a report by ICICI Direct.

The collapse of Silicon Valley Bank and Signature Bank in the US in less than a week and Credit Suisse teetering on the edge has also raised fears of contagion risk spreading across the financial sector, threatening to derail global economic recovery.

According to the International Monetary Fund’s latest World Economic Outlook, the global economy is expected to grow slower in 2023 compared to last year at 2.9% against 3.4% in 2022.

“Risk-off sentiment and global developments have potential to endanger financial stability and derail recovery significantly,” said a report by HDFC MF, underlining how this crisis makes bonds a better vehicle for investments than equities.

Peak rates on the horizon

The banking sector crisis could also force the US Fed’s Federal Open Market Committee (FOMC) to halt its rate hikes – analysts now expect a 100 basis point cut in FY24, with the cuts expected to start as early as June this year. This is after the FOMC hiked interest rates by 425 basis points since May 2022, spread across seven hikes.

“The priority for the US Federal Reserve may shift to financial stability and could now take precedence over elevated inflation,” the ICICI Direct report added, stating that this has also eased pressure on the Monetary Policy Committee (MPC) to announce another 25 basis point hike in April.

Even if the MPC announces another rate hike, the bond markets have already priced it in, according to analysts.

“Nevertheless, there are convincing arguments that the RBI is close to peak rate and repo rate is not likely to rise significantly beyond the current levels considering the current situation. This is largely priced in the current yield levels, in our view,” the HDFC MF report added.

Time to accumulate bonds

With the case for peak rates growing stronger due to the turmoil in financial markets, experts suggest now is the time to accumulate bonds.

“We believe there is a strong case to increase duration on fixed income portfolios by investors considering the flat yield curve and elevated absolute level of yields across the board. Hence, it is time to accumulate,” said the HDFC MF report.

Indian equity markets have also lost a lot of steam, with the benchmark Nifty50 giving up all of its gains of 2022 and then some – Nifty50 has corrected by 6.6% in 2023 so far, as against gains of 4.3% in 2022.

With interest rates expected to peak, economic recovery on shaky grounds and the decline in equity markets, analysts say bond markets look attractive.

“The yields across debt mutual funds have risen and offer an excellent investment opportunity. Investors should consider lumpsum investment opportunities as well,” said the ICICI Direct report.

What also makes bonds attractive is the significant rise in yields – according to the ICICIDirect report, yields on 3-year AAA-rated corporate bonds have increased from 4.7% in October 2020 to 7.9% now.

Making the case for investing in bonds, the report adds that the yield-to-maturity (YTM) of a bond is a good indicator of future returns in a stable rate environment. The report further adds that with peak rates on the horizon, the potential of a further rise in yields is minimal and therefore, returns are expected to be at these levels or marginally higher going forward.

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