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Fixed income markets witnessed an anti-climax for the second time in the last three months. While the Reserve Bank of India (RBI) did not deliver a much-expected rate hike, the US Federal Reserve commenced the process of tapering, much against the wider expectation of a further delay. This was in sharp contrast to September when RBI hiked the key rates and Fed had deferred the tapering. Markets absorbed both surprises with relative calm as neither the Indian or global markets over-reacted. Even though CPI inflation was shockingly higher at 11.24% and WPI inflation shot up to 7.52% with the September figures revised upwards to 7.05% vs 6.46% provisional, RBI held back the rate hike as it expects vegetable prices to ease significantly in December. Benchmark 10-year government securities, after spiking to a high of 8.95% on high inflation data, eased back to 8.75% as rates were not hiked and finally settled down at 8.80%, down 11 basis points for the week. Advance tax outflows during the week and anticipation of tighter liquidity ahead due to reduced government spending led to overnight rates shifting back to hug the marginal standing facility (MSF) rate of 8.75%. Both the dollar in global markets and the rupee in domestic market remained relatively stable in this eventful week. The euro-dollar strengthened marginally to 1.3673 vs 1.3742 and dollar also improved marginally to 62.05 vs 62.13 for the week. While ten-year AAA yield eased by a nominal 1 bps from 9.63% to 9.62% on subdued volumes, five-year AAA yields eased 10 bps from 9.75% to 9.65% reflecting uncertainty ahead.
Tight system liquidity was reflected in higher liquidity adjustment facility outstanding of Rs 41,100 crore from Rs 25,500 crore and higher MSF balances of Rs 17,200 crore vs a mere INR 500 crore. A status quo policy from RBI though helped short term rates remain stable with three month bank certificates of deposit rates easing a marginal 3 bps to 8.67 from 8.70% with one year CD rates remaining flat at 9.30%.
Raghuram Rajan while maintaining status quo on policy rates expressed his concerns on the rising inflation and said that if inflation excluding food and fuel remains sticky, RBI would act including on off-policy dates if warranted. He also indicated a tactical preparedness for expected US Fed tapering. The policy statement cited four reasons for the pause namely fall in vegetable prices in the last couple of weeks, a stable exchange rate, negative output gap and lagged impact of monetary tightening. The US Fed, one would feel, was left with little option but taper as their GDP grew 4.1% in Q3CY13 and unemployment rate slid to 7%. Given the past experience, the Fed is expected to continue to taper gradually in the coming months, once it has pressed the trigger. RBI has demonstrated great courage and confidence by withholding a rate cut in spite of raging inflation in anticipation of positive expectations. As such, if markets show stability in coming weeks, one can expect RBI to remain on hold for the time being. Even then uncertainty will remain due to concerns on fiscal deficit and political uncertainty. The edginess on account of an off-policy action from RBI will keep the market anticipating after every data point release. We expect the market to remain volatile with a downward bias for now. Current strategy should be to buy on corrections to take advantage of volatility until an adverse data point is visible.
Mahendra Jajoo is executive director & CIO-fixed income at Pramerica Asset Managers
