Crude oil prices and Gilt Funds

A cursory look at some of the bond funds investing in long-term government bonds shows that bond funds have given annualised returns of anywhere between 45 to 55 per cent. One of the reasons for such return is fall in the bond yields, which has fallen by 80 basis points from its recent high. This is triggered by fall in the crude oil prices.
One of the highlights of the year 2018 was the rise and fall of crude oil prices. From its low of US$ 62 per barrel in the month of February 2018, it touched a high of US$ 86 per barrel in a span of eight months. What was more dramatic was its drastic fall in the next two months to a 14 month low of US$ 56 per barrel. Such volatility has great implication for the Indian economy. This is because India fulfils 82 per cent of its requirement through import and had spent Rs. 5,66,450 crore in the last fiscal. This negatively impacts the government finances due to the increase in government borrowings. The impact of all this is reflected in the bond funds, especially, those that invest their major part in long-term government bonds and hence this extraordinary returns in the last one month.

To understand the relationship between both factors we charted daily returns of SBI ETF 10-year gilt fund and Brent Crude between September 2016 and December 2018. The below graph shows there is a somewhat inverse relationship between the returns by crude oil and the fund. However, you cannot draw any conclusive about that.


 
Therefore, we did a study of their rolling correlation between both in the same period. Again we did not arrive at any conclusive evidence of a negative correlation between both the factors. The graph below shows the rolling correlation of one-month between both factors.

 
 
Hence, there are factors other than crude oil that impact the bond yields and returns provided by these funds. Currently, as macros of the economy are improving, it is resulting in fall of bond yields and a rise in prices of bond funds.