An eventful week for debt markets

Fixed income markets saw continued correction last week with bond yields inching higher as hopes of another rate cut in the monetary policy review subsided further. Reflecting the ongoing anxiety in global markets on the possibility of major central banks slowing down on quantitative easing, and like in other emerging markets and Asian peers, the rupee extended last week's losses this week. Early in the week itself, the rupee nosedived to 59/$ mark before the central bank intervened and arrested the free fall, and the currency retraced back to close the week at 57.52 mark by the weekend on short covering/profit booking. In a positive development, rating agency Fitch upgraded India's credit rating to stable from negative, largely due to the government's continued strong commitment to fiscal consolidation and sowing inflation. The finance minister and other senior officials held a press conference during the week that helped restore confidence in currency markets and improved sentiment. A government statement that gold imports have fallen sharply since mid-May after recent measures to tighten gold imports also helped in improving sentiment.

The current depreciation in the rupee may put fresh pressure on inflation and fiscal deficit through higher subsidy bill. Further, analysts feel that there may be more downside to the currency in coming months. Countries like Indonesia, Brazil and Turkey have already raised interest rates in past weeks to defend the currency. In such a scenario, RBI may also keep interest rates on hold today even though slowing growth and lower inflation may warrant further monetary easing. Future rate cuts also become somewhat uncertain as that will require current turmoil in global markets to settle down quickly.

Even though WPI inflation came in lower at 4.70%, CPI was disappointing at 9.31%, higher than expectation of a below 9% print. Crude oil also spiked back to close above $106/bl in international markets. That kept the markets nervous. Benchmark 10-year government bond yield hardened 7 bps to 7.31%, while corporate bond yields hardened 17 bps. Money market rates also spiked by 10-15bps as RBI stayed away from any liquidity injection measures including open market operations.

All eyes are now on the monetary policy announcement on Monday. While no rate cut is largely priced in by the market, the guidance by RBI on future trajectory would be critical to fresh price action. The next FOMC meeting is scheduled later in the week where more clarity is expected on Fed's thoughts on rolling back the bond buyback plan which would determine course of global markets that has caused the current round of volatility.

As such while this week encounters many event risks, nonetheless it also will provide clearer guidance. Although fixed income markets have corrected somewhat in the last two weeks, a quick recovery is unlikely. In case event outcomes turn out positive, markets may stabilise with a mild rebound. A cautious approach is warranted till visibility improves.

Mahendra Jajoo is executive director & CIO - fixed income at Pramerica Asset Managers