The US Federal Reserve kept its interest rate target in the 0.25% to 0.5% range, while reiterating its accommodative stance on monetary policy. The Fed assessed that while economic activity is likely to pick-up as headwinds to the US' recovery prospects get alleviated, inflation continues to remain low. The agency opines that the Fed will be cautious before proceeding with the first rate hike in 2016, even as it leaves the door open to normalise rates before the end of 2016.
Following the extended period of low economic activity and the possible geopolitical risks post Brexit, global central banks have stayed circumspect of the ongoing fragile recovery and demonstrated their readiness to use the available means to boost the economy. Last week, the European Central Bank indicated that it is ready to take fresh action in order to stimulate the economy, if needed. Additionally, yesterday, Japanese policymakers renewed their efforts to revive the faltering domestic economy- announcing a stimulus package of USD265bn.
On the domestic front, the 10-year benchmark G-sec yield dropped to 7.21% in early trade today- lowest in over three years, on the back of strong foreign portfolio investor interest. Since the start of July 2016, post the increase in the debt investment limits, foreign portfolio investors have bought G-sec worth net INR81bn. On the other hand, the reined in volatility in the rupee also enhances the attractiveness of Indian assets among other emerging markets.
The yields on G-sec are likely to stay soft in the near term; even as the agency believes a major chunk of the rally is already underway. The three key factors which are likely to boost the ongoing positive momentum in domestic debt markets and lead to a flattening of the curve are (1) high spread differential (between major global yields and domestic G-sec yields, as also between domestic overnight rates and longer tenor yields) (2) Reserve Bank of India's endeavor to keep liquidity close to the neutral zone- ensuring adequate systemic liquidity (3) reserve money accretion through incremental open market operation purchases of G-sec. The Reserve Bank of India has already conducted open market purchase operations worth INR800bn since April 2016- negating part of INR1.56trn net G-sec supply till date.
Accommodative central banks and ensuring risk preference will augur well for the Indian currency in the near term. Barring the US Fed, most major central banks have exhibited their preference to stay on the easing course- thus ensuring the rupee stays anchored. The agency believes that, in the near term, the rupee is likely to trade with an overall stable bias as investors focus on the ongoing monsoon session of parliament to discern signs of the meaningful progress on key reforms along-with the corporate earnings season.
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