Expect a dovish stance from RBI: Jajoo

The outlook for the bond market and money market is looking much better for this week

In line with expectations, bond prices continued to rally last week with the 10-year benchmark government bond yield touching a three-month low of 8.57%. The sharp drop in perishables and food inflation by 6.36% month-on-month led to sharply lower CPI/WPI prints. This was in line with the stated guidance in RBI’s December policy review wherein it refrained from hiking rates citing its expectations of sharp fall in vegetables being one of the key reasons. The December CPI came in at 9.87%, while WPI was reported at 6.16% reversing the recent trajectory of rising prices.
 
The benchmark 10-year bond began the week on a stronger note at 8.72% tracking the overnight gains in US treasury following weak US non-farm payroll data last Friday. Although CPI came lower than market expectations, core CPI remained sticky at 8.05% which led to some mild correction in bonds. However with WPI numbers throwing a sharp positive surprise defying lowest of the market estimates coupled with positive statements from lawmakers, led to renewed euphoria in the markets. FM hinted at pegging fiscal deficit at 4.65%, lower than budgeted target of 4.8%. The government after initially announcing deferment of a scheduled auction for Rs 15,000 crore stated that the final borrowing for the current fiscal will be reduced by this amount. Ten year bonds rallied all the way till 8.57%. However another news item of a possible switch of government debt at market prices on bilateral basis next week led to some immediate knee jerk reaction in closing hours of the week on Friday with 10 year losing some of its gains to close at 8.63%, down by 13 bps for the week. Despite the US dollar strengthening against major currencies globally, the rupee strengthened to 61.55 from 61.91 as domestic developments took precedence over global events. Post market hours, RBI announced an open market operation purchase for Rs 10,000 crore of dated government securities which promises continued rally into the next week as well. Ten year AAA corporate bond yields fell 11 bps to 9.51% from 9.62%, while five year AAA fell 10 bps from 9.64% to 9.54%.

 
Government expenditure cuts continued to weigh on market as liquidity conditions continued to remain tight. The liquidity adjustment facility borrowings rose to Rs 39,700 crore from Rs 33,300 crore  and marginal stability facility balances stood at Rs 7,215 crore. MSF borrowings were negligible last week. Overnight rates remained close to MSF rate of 8.75%. RBI announced a 28 day term repo wherein cut-off stood at 8.43%. It also helped stabilize the sentiments in the money markets. Three month bank certificate of deposit rates inched up 5 bps to 9.15% from 9.10%. One year bank CD rates edged up marginally to 9.33% from 9.32%.

 

A term repo for 28 days this week and announcement of an OMO for purchase of dated securities post market hours on Friday clearly indicates RBI guidance for further easing in bond yields in the coming week. Continued strength in the rupee and stable US 10 year bond yields are also expected to help sentiments. Analysts are now predicting WPI inflation to fall further to near 5% by March. This softening trajectory of inflation strengthens the case for a more dovish stance from RBI in the upcoming policy and puts the odds in favor of continued pause in policy rates. The concerns over government meeting its fiscal deficit targets also have disappeared with a reduction in borrowing programme by Rs 15,000 crore. This is like a dramatic u-turn of events in the last week and suggests a positive stance for now. Liquidity is likely to remain on tighter side due to seasonal factors but repetitive pre-emptive liquidity injection measures by RBI suggest buying on every spike in short-term rates.

 
Mahendra Jajoo is executive director & CIO at Pramerica Asset Managers