May CPI print likely to be lower on base effect: Jajoo

The RBI policy guidance suggests growing comfort to tackle inflation pressures with support from new government's structural reforms

Fixed income markets picked up further momentum with participants picking up first signals of softening bias in RBI’s monetary policy review released last week. While RBI left key policy rates unchanged, it reduced the statutory liquidity ratio (SLR) requirement for banks by 50 basis points from 23% to 22.5%. It also reallocated part of the existing export refinance facility by reducing the eligibility from current 50% to 32% of outstanding export credit and increasing the term repo availability in LAF by 0.25% of NDTL. Both these measures were welcomed by markets as being growth supportive. RBI also indicated that as per current projections, further monetary tightening may not be required and if inflation eases at a faster pace, there would be scope to cut rates.

 
These positive comments triggered a renewed buying spree with benchmark 10-year easing all the way to 8.51% by close, down 13 bps from 8.64% last week. The five-year AAA bonds fell 13 bps from 9.28% to 9.15%, while 10-year AAA bonds eased 12 bps from 9.31% to 9.19%. The rupee which had weakened to 59.34 intra-week ended at 59.18 little changed from 59.10 last week. Despite domestic equity making new highs, gains in the rupee were capped on RBI intervention. In global markets, ECB eased all major interest rates in its policy decision. The benchmark refinancing rate was cut by 10 bps to 0.15%, the deposit rate reduced to -0.10% and the marginal lending facility was cut by 35 bps to 0.40%. It also announced two targeted long-term refinance operations worth EUR 400bn, to be conducted in September and December 2014 (maturing in September 2018). The euro-dollar pair was broadly unchanged for the week as the event was priced in by the markets. The positive jobs data in US led to some profit taking in US bonds with 10-year treasury inching up 9 bps to 2.57%.

 
Liquidity was fairly comfortable throughout the week as overnight CBLO rates traded tad below 8%.The LAF borrowings further fell from Rs 8,966 crore to Rs 2,845 crore. There were no MSF borrowings reported. The weighted average cut off on special 28D term repo stood at 8.17%wherein RBI infused partial amount of Rs 9,125 crore vs notified amount of Rs 20,000 crore. The three month PSU Bank CD rates fell another 4 bps from 8.57% to 8.53% while one-year certificates of deposit rates nudged lower by 7 bps to 8.88% from 8.95%.
 

The RBI policy guidance suggests growing comfort to tackle inflation pressures with support from structural reforms from new government. Also, in 2014 so far FIIs have already pumped in $8.2bn in domestic debt markets. With the likelihood of a new benchmark 10-year bond later in the month, bond yields have room for further easing. The market will witness periodic consolidation as any rate cut is still some distance away. With a strong base effect, CPI for May is also likely to print lower. The winning strategy would be to stay invested in relative value stocks and to buy on dips. The short end rates are expected to be well anchored near their recent lows as RBI has provided June quarter crossing liquidity through special 28 day term repo and the overnight LAF window also stands unutilised to a large extent.

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