Short Term Debt Funds - An Interesting Investment Opportunity At Higher Yields

Sensing an expected increase in rural inflation due to increase in Minimum Support Prices (MSP) of Kharif crops, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI)announced an increase in policy rates once again.

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Policy rates were hiked by 25 bps and it was for the first time in five years that the rates were increased in two consecutive meetings.

The increase in the policy rates aims to make credit costlier for the borrowers, which will translate into lower demand for goods and thus lowering of the inflation. The immediate reaction on the rate hike announcement in the bond markets resulted in yields moderating a little, as the MPC maintained its neutral stance on the economic outlook and emphasised to stay data-dependent for further policy decisions. However, the yields could have cooled off in spite of the rate hike as the policy action was almost factored in by the markets.

The interest rate scenario and yields are closely interlinked. The yields adjust through the market forces to reflect the prevailing interest rates in the market. As such, the market prices of the securities and yields are inversely proportional. Accordingly, as and when the yields increase, the market price of the debt securities decrease. This inverse relationship also gives rise to the interest rate risk for investors in the fixed income market. This is due to the fact that as there is an interest rate action, market value of fixed income securities changes accordingly.