Bonds to find support in current range: Jajoo

Fixed income markets maintained the positive momentum of the previous week for most of last week before losing the advantage in the last few hours of Friday to give up all the gains and with benchmark 10 year government bonds yield closing 3 bps higher at 8.88%. Buoyed by strong institutional support and trader interest, bonds continued to rally with 10 year government bond yield hitting an intra week low of 8.81%.
However, the release of the minutes of the last technical advisory committee of RBI on monetary policy on Friday afternoon turned around the positive sentiment. As per the minutes, most of the members felt that moderation in vegetable prices drove the recent softening of headline inflation and this was unlikely to be sustained. In their opinion there were clear upside risks  such as suppressed pricing in electricity, fuel items, impact of hailstorms on select food prices, increase in NREGA employment guarantee by 50 days and decline in female labour force participation. They also expressed concerns over sticky core CPI since inflation in housing, education and medical care had remained elevated.  Though there was hardly any surprise in the minutes as such, it acted as a reminder of still very cautious stance of RBI at a time when the bonds have been rallying for past few sessions and triggered profit booking by traders.

Institutions and investors still remained huge buyers as evident from the trade data on Friday where banks and mutual funds were buyers to the extent of Rs 5,634 crore with primary dealers and foreign/private banks being the sellers. With US 10 year yields easing to 2.66% on Friday, markets should continue to find support for now. The lack of fresh issuances in corporate bonds coupled with the demand from mutual funds led to further contraction of spreads. The five year AAA ended 15 bps lower for the week at 9.52%, while 10 year AAA yields fell 17 bps to end at 9.53% from 9.70%. The rupee continued to face weakness in the face of slowing overseas flows and closed weaker at 60.63 vs 60.29 last week.

 
In money markets, overnight rates were trading higher in 8.40-8.60% range driven by strong demand due to large position building in bonds by traders also evident by significant increase in liquidity adjustment facility balances at Rs 21,009 crore vs Rs 11,200 crore the previous week. The three month bank PSU bank certificate of deposit rates rose 5 bps to 9.05% from 9.00%, while one year bank CD rates remained flattish at 9.22%.

 
With continued strong buying by institutions, bond markets should remain supported in current range. Traders will watch for further cues from the Fed meeting next week. Underlying momentum remains strong though headwinds on higher inflation and global factors may not allow any significant decline in yields keeping the markets range bound. Money markets will likely continue to remain lacklustre in the absence of any major driving factor.

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