Expect further correction in bonds for a few days: Mahendra Jajoo

However, valuations are beginning to look reasonable and opportunity to build fresh bargain positions will be available soon

With Fed guidance on tapering of the bond buyback turning out much more hawkish than market expectations, global markets of bonds, currencies and commodities went through another round of a sharp correction this week. The only shining star was the US dollar which strengthened strongly. The US 10-year yields hardened another 30 bps to hit 2.50% mark, resulting in a cumulative lift of 90bps from a low of 1.60% since last year. The rupee hit a fresh all-time low of 60 against the greenback before settling down at 59.25.
 
With increased apprehension of a slowdown in capital flows and the cascading impact of weaker rupee on inflation, Indian fixed income markets went into a freeze the morning after the Fed announcement. Bond markets opened on downward circuit on Thursday and trading could resume only after regulators abandoned the lower circuit for the day. In all, the benchmark 10-year government bond yields went up 20 bps for the week. Broader market yields on government bonds and corporate bonds were up an average of 15 bps for the week. RBI largely refrained from any action including no rate cuts in monetary policy review except for a mild intervention to arrest the free fall in rupee.

So far the Indian markets have shown far more resilience than other emerging markets in the peer group. This stems from underlying optimism on two counts, first that domestic factors like falling  inflation, ongoing fiscal consolidation and faltering growth are strongly supportive of softer rates. And secondly that this global avalanche is a one-off short-term event which will settle down in due course.

And that optimism may not be entirely misplaced either. While the first round impact of the current developments has been negative for India, there are a few positive second round impacts. For example, international gold prices have crashed on fears of removal of excess liquidity. A similar fate awaits other commodity prices. This will ease the burden on current account deficit (CAD), which has been much of the cause of the current heartburn. Secondly, if as Fed estimates, US economy strengthens, prospects for exports will brighten further aiding to contain CAD. Fears of reversal in current softening in inflation may turn out exaggerated as lower commodity prices may neutralise adverse impact of weaker rupee. Finally, once the exuberance of last couple of years due to flood of liquidity diminishes , fundamental factors of growth potential like demographics and lifestyle changes may again place India as one of the most cherished investment destination. However, for this to happen, we need to survive an irreparable damage to confidence in minds of international investors. Current excellent handling of the crisis by the authorities like continued focus on fiscal consolidation, RBI's largely non-interventionist approach in allowing market forces to play themselves out by holding back on rate cut and letting the rupee depreciate in line with other peer group currency baskets, taking effective steps like restriction on gold imports just at the right time, market pricing of oil products and thereby improving fiscal situation and dampening demand, showing urgency in resolving critical issues holding back infrastructure development and industrial revival through fresh set of policy measures are likely to go a long way in keeping the growth potential intact once the current turbulent phases passes and normalcy returns.

Global markets are still reconciling to the unexpected hawkishness and urgency shown by the Fed in rolling back the bond buyback programme as evident by continued strength in dollar index and further uptick in US treasury yields in Friday's trading. As such, expectations would be for further correction in early part of the next week. However, valuations are beginning to look reasonable and opportunity to build fresh bargain positions will be available once the signs of stability appear on the horizon. Opportunity to deploy cash generated through a cautious approach suggested in last two weeks will shortly present itself. One needs to closely watch the markets for early signs of consolidation.

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