Fixed income markets had a strong start on Monday with the rupee appreciating another 2.5% for the week to 63.50. There were no cash management bill or government securities auctions during the week and a better than expected non-farm payroll data in the US on Friday. However, bond markets remained volatile thereafter giving up much of the early gain. In fact, the only segment closing the week in positive was benchmark 10-year government bond with yields down 14 basis points (bps) to 8.49%. Otherwise, corporate bond yields were up by 5-10 bps and so were the money market rates with most of the concession coming in towards the end of the week when the Prime Minister's Economic Advisory Council released its quarterly review.
The PMEAC scaled down the GDP forecast for FY14 to 5.3% and suggested that meeting fiscal targets of 4.8% of GDP may be quite challenging. It also indicated that inflation is likely to remain elevated with recent rupee depreciation and that current monetary policy stance of higher short term rates may need to be retained a bit longer till the currency markets stabilised. The rupee also showed signs of fatigue after the sharp appreciation in the last two weeks. Though the IIP for July was reported much higher than consensus at 2.6%, most of the gain came from capital goods which did not provide much optimism for coming months. CPI for August was still very high at 9.52% but the trade deficit for August at $10.92bn was more disappointing, only marginally better even after the significant drop in gold imports. The one silver lining was the continued pick-up in exports which grew 13% y-o-y in August continuing on the 11.6% expansion in July, led by improving global demand.
Overall, while the sentiment has improved, the released data has very little to push the optimism very far. Growth outlook remains subdued and inflationary expectations high. The all-important Fed meeting is scheduled on September 18 followed by RBI's monetary policy review. The Fed may sound more hawkish than current market expectations as economic data in the US has remained robust and the Fed has indicated mid-2014 to unwind the bond purchase completely. There are only seven FOMC meetings till then and with current Fed chairman retiring by end-2013, it may plan to unwind half of the current bond buying programme of $85 bn per month. In any case, if the Fed commences tapering, the following months are unlikely to offer any breathing space. All indications are for RBI to maintain the current tight policy stance in the policy review. Given that, we expect the markets to remain volatile and correct further this week. In case the Fed is dovish or RBI scales down the tightening, traders can book profits in any rally that may follow.
Mahendra Jajoo is Executive Director & CIO-Fixed Income at Pramerica Asset Managers
