Ind-Ra: Eyes on CPI before US Fed Policy

US Fed's policy outcome and communique is likely to signal an imminent rate hike in upcoming months, while holding rates have steadied ahead of the Brexit in this week's meeting, says India Ratings and Research (Ind-Ra). Consequently, both debt and currency markets are likely to note a week of volatility as the domestic retail inflation data as well as the Fed's policy outcome will be in focus. The benchmark 10-year G-sec is likely to be in the 7.46%-7.56% range this week (7.49% at close on 10 June 2016), while the rupee might range between 66.40/USD-67.35/USD (66.76/USD at close on 10 June 2016).

Inflation to Aggravate Bond Market's Vulnerability: Ind-Ra believes an increase in retail inflation, aggravated by rising food prices and a sharp recovery in global commodity prices, will keep the Reserve Bank of India's (RBI) stance guarded as it strives to steer the economy towards its 5% inflation target by March 2017. Any number higher than 5.4% will cause a shift towards cautiousness in market sentiment. Consequently, the yield may inch up to 7.55% with low expectations of a rate cut in the near term.

Liquidity Conditions Tight on Tax Outflows: Ahead of FY17's first tranche of advance tax outflows this week, Ind-Ra believes liquidity conditions are likely to note frictional tightness without a shift in core liquidity. The agency expects core liquidity to shift to 0.5% of net demand and time liabilities (NDTL) from 0.25% of NDTL currently. Overall liquidity is estimated to move towards 0.75%-1% of NDTL from 0.5% currently.

Rupee Braces For a Volatile Week: While Ind-Ra believes the Fed is unlikely to raise rates this week, a signal about the imminent rate hike in upcoming policy meetings will keep the rupee swinging in a large range. With the low probability of a Fed rate hike, communication from the Fed will be critical and is likely to be positive for the rupee. Clarity in the form of communication as well as the future trajectory of the Fed funds rate is likely to augur well for the rupee in the upcoming week.

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