Markets expecting a rate cut this week: Mahendra Jajoo

There may be some amount of profit booking and consolidation post the rate cut announcement unless there is a 50 bps rate cut

Two weeks after the budget, bond markets remained volatile but are now showing signs of settling down. Standard & Poor’s has indicated that it may upgrade India rating outlook to stable if the government continues to progress on the path of fiscal consolidation. In a data heavy week, dichotomy remains the central theme though on balance, a trend improvement in economic environment is becoming clear. Trade deficit narrowed to $15 bn for February with exports growing 4.5% and a marginal decline in oil and gold imports. With the current account deficit being the strongest headwind at present, this is perhaps the most positive economic news this quarter. And this does not seem to be a one-off, going by a similarly strong rebound in exports and trade surplus registered by China in the last two months.

The index of industrial production registered a 2.4% growth in January after contracting in the previous few months. Monthly wholesale price index for February came in at 6.8%, higher than market expectation, but core manufacturing inflation was below 4%, the first time in last three years. On the negative side, consumer price inflation remains unacceptably high at near 11%. The RBI governor commented very favourably about the government’s fiscal consolidation measures and suggested concerns of an adverse impact on current account deficit due to a rate cut as being overrated. Crude oil prices eased significantly below $110 a barrel enabling oil companies to cut petrol prices by Rs 2 per litre and desisting from hiking diesel prices.

Money market rates eased sharply by 25-30 basis points in spite of continued liquidity tightness and approaching advance tax outflows due to strong demand from mutual funds and reduced supply from banks. There are signs of some position building by traders in anticipation of a rate cut in this week's monetary policy. Given that banks’ deposit growth in the year so far is still below that of credit, there could be strong supplies next week and may lead to some reversal in money market rates next week. Government bond yields moved up marginally by 2-3 bps as traders remains sandwiched between high CPI inflation and poor growth data. Corporate bond spreads though contracted yet again by 10 bps.

A rate cut in coming policy appears sealed at this stage and the market is holding large trading positions. A rate cut with an accommodative guidance may still leave some more upside for bonds. The borrowing calendar for the first half of FY14 to be announced next week will again provide a fresh direction.

Considering all possibilities, some amount of profit booking and consolidation post the rate cut announcement is likely unless of course there is a 50 bps rate cut.