DebtFx: Week of Fresh Volatility

Signalling confidence in the US economy's recovery, Fed Chair Janet Yellen left room open for a rate hike in the September 2016 policy review. On cue from this, the bond market is likely to consolidate with a bias towards hardening of yields; additionally, the rupee could face headwinds. The 10-year yield is likely to trade at 7.10%-7.18% (7.13% at close on 22 August) and the rupee's trading range could stay at 66.85/USD-67.45/USD (67.06/USD at close on 22 August) this week.

Bonds Steady: The domestic bond market has been consolidating in the absence of clarity. The agency believes market participants would await clarity to assess the scope and chances of a rate action in the foreseeable future. This would only be possible by way of communication from the new Reserve Bank of India (RBI) Governor. Until then, the market would be in 'wait and watch' mode and more sensitive to the US markets. The agency believes muted buying appetite would keep hardening bias for yields.

Surplus Liquidity to Neutralise: Liquidity has remained in surplus, with net core liquidity absorption by RBI staying above 0.25% of net demand and time liabilities. The agency expects the liquidity condition to remain buoyant in the next week. However, the situation is likely to taper from the following week as redemptions of foreign currency non-resident (FCNR) deposits cue up, with net core liquidity coming back to the neutral zone from the current surplus zone. The agency does not expect any open market operation purchases prior to the middle of September.

Headwinds for Rupee: The agency believes the renewed probability of a Fed rate hike will pose minor headwinds for the rupee's trajectory. Additionally, FCNR deposit redemption may aggravate pressure in the near term. While the RBI asserted readiness to meet any possible mismatches, short-term volatility may not augur positively for the rupee.

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