Fixed income valuations not cheap: Jajoo

Brace for another week of volatility and weakness

The tailspin in rupee and bonds continued unabated in the early part of the week. The rupee crashed to hit yet another life time low of 65 by mid-week, down 5% from previous week's closing of 62.71. Trailing the panic in currency markets, the benchmark 10-year yield also hit an intra-day high of 9.48% on Tuesday, a spike of almost 60bps compared to previous week's close. The Fed minutes released during the week suggested a broad consensus on tapering amongst its members. The sense of panic that gripped the markets was further aggravated by continued slide in currency and bond markets in other peer economies like Indonesia and Brazil. 10-year AAA PSU bond yield also hit a high of 10.50% and one-year bank certificates of deposit (CD) rates breached past the 11% mark. RBI gave a cut-off of over 12% in weekly cash management bill auction.

Concerned with the sharp rise in yields at such a fast pace, RBI announced an open market operation (OMO) purchase for long-dated bonds. Both RBI and finance ministry officials indicated that current tightening measures are targeted towards the short end and such a sharp uptick in long bond yields was not intended.

Market sentiments improved instantaneously and benchmark 10-year yield opened at 8.25% on Wednesday. In another soothing measure, RBI essentially allowed the banks to carry government bonds to the extent of an additional 1.5% of their deposits at cost without having to book the mark-to-market loss providing a significant relief for banks profitability. The finance minister also held a press conference, once again reiterating the government’s commitment to keep current account deficit under $70 billion. This relaxed the frayed nerves of the market somewhat and the rupee appreciated back to 63.33 by close of the week, though still down 2.6% for the week but with much better sentiments. Given the uncertainty, corporate bonds continued to languish and saw one of the worst underperformance in recent times with yields down just about 30 bps at 9.50%.

With a realistic expectation of small moderation in current account deficit, the rupee may get some breathing space for now. However, the rebound in the past week should still be considered as a relief rally. The underlying situation still remains very volatile. RBI announced another auction of CMBs for next week of Rs 22,000 crore, this time with maturity falling in October, past the current quarter. The marginal easing in short term rates witnessed last week is most likely to be wiped out this week. Long bonds may remain anchored for now but in the likely scenario of RBI not announcing another OMO this week will again witness profit booking. A number of analysts are beginning to suggest that markets are already pricing in the first round effect of the Fed tapering by year end. While that seems reasonable, the visibility on capital flows remains very poor. Oil prices, which have once again hit $111/bl, could have adverse impact on inflation in the coming festive season with the cascading impact of the weaker rupee. Growth will also be constrained with the government, the largest spender, committed to fiscal consolidation. With the rebound last week, even valuations are not seeming cheap any more. One braces for another week of volatility and weakness.