RBI policy to set the trend in debt market: Jajoo

Fixed income markets maintained the strong positive undercurrent buoyed by hopes of structural reforms by the new government and improved liquidity though volatility was still higher compared to recent weeks. In early part of the week, jittery traders caused benchmark 10-year government bond yield to hit 8.70% as some feared an upward revision in borrowings in the forthcoming Budget to address unpaid subsidies bill. However announcement of a new 14-year benchmark bond and statements from the new finance minister reinforcing commitment to lowering fiscal deficits, tackling inflation and supporting growth resulted in an immediate rally. The 10-year bond retraced back to its recent lows at 8.62.

The market turned jittery again as RBI Governor reiterated the need to bring down inflation as top priority. However, the benchmark 10-year maintained the broad range of 8.65% to 8.70%. The final trading session witnessed most of the volatility on a slew of statements from the RBI chief. While addressing a conference in Tokyo, Raghuram Rajan said that both the government and the central bank shall work together to bring down inflation, while respecting the fact that economic growth was very weak. He also expressed satisfaction with new government's plan to curb food inflation. He was hopeful that the general public’s inflation expectations were likely to decrease in future. As a result there was a renewed buying spree and the 10-year slipped back to week's low of 8.60%.

When auction results were announced, where the cut-off on the new 14-year bond came in at an aggressive 8.60%, there was another bout of selling. The benchmark 10-year eventually settled at 8.64%, higher by 1 basis point for the week. Corporate bond yields continued to drop on lack of fresh supplies and strong FII buying. The five year AAA yields fell 4bps from 9.32% to 9.28%, while 10-year AAA bonds eased 5bps to 9.31% from 9.36%. Bonds also received support from global markets where 10-year US treasury yield eased to a low of 2.42% before closing the week at 2.46% as US GDP for Q14 contracted by 1% due to poor weather conditions and slower inventory build-up.

 

Q4 FY2014 GDP grew 4.6% YoY taking FY2014 growth to 4.7%. Some support for growth came from agriculture and net exports.  Non-farm GDP was muted and investment continued to contract. Final FY14 fiscal deficit stood lower at 4.5% from the revised budget estimates of 4.6%. India's current account deficit sharply narrowed to 1.7% of GDP in FY2014 from 4.8% in FY2013. The improvement was primarily on account of lower trade deficit, reduced gold imports and higher contribution from invisibles. Correction in domestic equities coupled with month end dollar demand from state run banks led to some weakness in the rupee which ended at 59.10 from 58.50 against the dollar. In the face of renewed strength in US dollar in global markets, that was quite comforting.  The euro fell to its lowest level since January to 1.3635 on expectation of interest rate reduction by ECB.

 
The liquidity situation was comfortable throughout the week as overnight rates were stable around 8%. The liquidity adjustment facility borrowings fell from Rs 11,701 crore to Rs 8,966 crore. The weighted average cut off on 14 day term repo fell sharply to 8.06% versus 8.23% in previous auction. The marginal standing facility borrowings rose marginally from Rs 800 crore to Rs 1,708 crore. The three month PSU Bank CD rates also fell 18bps from 8.75% to 8.57%, while 1Y Bank CD rates ended lower by 5 bps to 8.95% from 9%. After closing hours RBI also announced 4 day term reverse repo auction of Rs 15,000 crore with a green shoe option to accept additional Rs 10,000 crore to be conducted on June 2.

 
Markets will now keenly watch for any subtle change in guidance from RBI in next week's monetary policy review, the first after the new government has been formed. With expectations of structural reforms, improving global markets and stabilising inflation, the market expects a scale-down in hawkish tone. That should continue to support the currently positive undertone and allow further drift down in bond yields over next few months. Apprehension of El Niño and large borrowing calendar though will continue to put a floor on bond yields in near term and also keep the markets volatile. Overall, the momentum suggests a buy on dips approach. With RBI continuing to build forex reserves, liquidity in the system is likely to improve further. This has taken the short term rates down in last two weeks. That momentum should continue although with no immediate hopes of a rate cut, further room for easing in short term rates remains limited.

 
Mahendra Jajoo is Executive Director & CIO- Fixed Income at Pramerica Asset Managers