Trading opportunities in debt markets this week: Jajoo

After the strong rally of the past two weeks, some correction can be expected

Fixed income markets had another good week thanks to a surprise cut in the marginal standing facility (MSF) rate by 50 bps to 9% by the Reserve Bank of India on Monday evening. Even as the market opened on Monday on a nervous note on continued stalemate in the US and bond yields inched up, the surprise cut in MSF rate significantly boosted sentiment subsequently. News flow for rest of the week also remained positive with the rupee appreciating another 0.5% to 61.08 on sustained dollar inflows, trade deficit for September shrinking further to a 30-month low of $6.7 bn and RBI introducing additional liquidity facility to the extent of 0.25% of NDTL of banks under liquidity adjustment facility by way of 7 and 14 day term repos.

 
Indications also came of further progress in talks on inclusion of Indian government bonds in JP Morgan Emerging Markets Bond Indices which can potentially result in significant allocations from global investors to Indian bonds. As expected, the maximum impact of liquidity easing measures was felt on short-end with three month Bank certificates of deposit (CD) rates easing by a 55 bps to 8.95% and one year bank CD rates easing 35 bps to 9.10%. Benchmark 10 year government bond yield eased 12 bps to 8.49% from 8.61% last week. It did test 8.40% intra-week but gave up some gains in the last hours of trade as traders booked profits and shredded positions ahead of release of key data points like IIP and CPI. Triple-A PSU 10 year bond yields also fell 12 bps to 9.44%.

 
After market hours on Friday, the IIP for August 2013 was reported at 0.6%, significantly lower than analyst’s expectation of 2%. All major sub-segments except electricity posted a decline. This compares poorly against IIP growth of 2.8% July and once again brings to fore the concerns on economic momentum.
 

On global fronts, early indications of the US avoiding an immediate debt default have emerged as Republicans and Democrats have begun negotiations. Picking these signals, US 10 year yields inched up 10 bps to 2.73% and Brent crude prices hardened to $111.28 a barrel from $109.46 a barrel last week.

 
This week has key data releases on both consumer and wholesale price indices. While wholesale inflation may come in marginally lower, CPI is expected to remain sticky around 9-9.5%. RBI in recent statements has consistently indicated concerns on inflation and a higher reading will lead to anticipation of another repo rate hike in the monetary policy review towards month end. Bond yields have already remained over 8.50% for past two weeks and may inch up again. However, RBI has also conducted open market operations to cap the rise in yields to ensure adequate availability of credit to productive sectors which should keep the yields in a tight range. While the market may open firm this week, much will depend on how the CPI number is received by the traders. After the strong rally of the past two weeks, some correction is expected but as mentioned, it will be a good trading opportunity. Liquidity should remain easy but with short term rates already hugging the MSF rate of 9%, not much possibility exists for an immediate drop in these rates. As such, the short end of a curve should remain stable with a marginal downward bias. With RBI sounding extremely confident on the external sector, evidenced by a quick follow-up cut in MSF rate this week even in the face of continued stalemate in the US, external sector is unlikely to take centrestage currently. Having said that, any dramatic turn in the US that rattles the global markets will definitely cause ripples domestically also though indications last available suggest a possible solution for avoiding a debt default by the US by extending the debt ceiling by at least six weeks.

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