Bonds likely to trade in a narrow range

Bond markets corrected this week after trading in a narrow range over much of last week. The new benchmark 10-year yields hardened by 12 basis points (bps) to 7.25%. AAA 10-year PSU bonds and one-year bank certificates of deposit rates also moved up by 15 bps in a near parallel movement. The proceedings in fixed income markets were guided by two major developments. Firstly, the rupee weakened further to an intra-week low of 57 mark, near its all time low of 57.30 on the back of global strength in the greenback and a sell-off in equities markets on fear of a slowdown in the Fed's bond buying programme. The obvious implication of this is an imminent tightness in domestic liquidity due to expected RBI intervention and a slowing down of capital flows. Secondly, the RBI governor commented that consumer inflation still remains high even though WPI inflation has come down and current account deficit remains under pressure. The market interpreted these comments as a reduced probability of a rate cut in June policy and sold off. After hitting an intra-week low of 7.30%, the old benchmark 10-year hit a low of 7.50% before some bargain buying set in, resulting in eventual closing at 7.44%.

This was a very healthy correction resulting in the transfer of floating stock into stronger hands. The market will now await the incoming data on monthly inflation and trade balance number for May, which will be released in the week starting June 10. While WPI inflation is expected to be reported well below 5%, consumer price inflation may come below 9% for May, and the trade balance is likely to come higher than $15 bn keeping the market on edge.

Pending that, bonds are likely to remain lacklustre in a narrow trading range. As the underlying momentum is strong and expectations of further easing in medium term remain strong, one cannot rule out a full retracement back to the previous low on bond yields though higher levels will attract profit booking. A sharp decline in crude oil prices back to $100 in Friday’s trading may add to this. Also favourable comments from finance ministry officials will support the momentum.

Recent developments like rupee weakness, RBI comments, risk-off momentum in global markets etc all suggest increasing probability of a pause in the current rate cut cycle in June policy as RBI's immediate priority would likely be to tackle the currency front and financing of current account deficit. However, a timely onset of monsoon in Kerala, satisfactory progress in fiscal consolidation (FY13 final fiscal deficit was at 4.89%) and a below-par growth still indicating a resumption in rate cuts later this year, should continue to strengthen this trend. As such, any correction, either ahead of the policy as the rate cut hopes dim or post policy if the rate cut is not delivered can provide a good opportunity for fresh positions. As the trading pattern evolves, one will get a better sense of a good entry point. Technical charts suggest 7.35% on the new benchmark to be a good reference point which mark is expected to be hit ahead of the policy.

 
Mahendra Jajoo is Executive Director & CIO- Fixed Income at Pramerica Asset Managers