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Fixed income markets started on a weak note last week, carrying the bearishness sparked by the repo rate hike of Friday resulting in amongst the poorest response in recent times at Monday's auction with devolvement of almost Rs 4,000 crore out of a total auction size of Rs 15,000 crore. Though the cut-off for 10-year benchmark bond came at 8.78%, in post auction market trading, it hit a high of 8.90%. On Wednesday, RBI issued a press release stating its intention to provide adequate liquidity including by way of open market operations whenever required. This provided some comfort to the market and Friday's auction drew good response with only marginal devolvement. The benchmark 10-year eventually closed at 8.71%, up 13 bps for the week at net level. Short term rates though continued to ease through the week, encouraged by the reduction in MSF rate last Friday by 75 bps to 9.50% as well as by RBI press release on assurance on liquidity management. Three-month bank certificate of deposit rates softened by nearly 15 bps each from last week’s levels of 9.80% to 9.65% while one year bank CD rates remained flat at 9.60%.
Domestic data to be released this week include current account balance for June quarter and fiscal deficit for the month of August. While current account data is relatively well analysed due to availability of trade deficit and capital flow data on monthly basis, broader market expectation is already for the current fiscal deficit target of 4.8% of GDP to be exceeded. In US, most important data for the week would be unemployment rate for September. However, the event that would draw maximum attention is the debt ceiling negotiations in the US. With the Fed already indecisive on tapering and preferring to be very non-committal, these data points can potentially cause some volatility in global markets.
The RBI governor once again indicated in one of the comments last week that inflation continues to be very high currently. Markets is also drawing the inference from recent comments and action that RBI may lean quite a lot more on consumer price inflation for policy framework in coming month, which index remains elevated near 10% for a longish period now. Simultaneously RBI is also strongly indicating further unwinding of emergency liquidity measures in coming policies. That sets the stage very clearly for a steepening of the yield curve and paradoxically, on this occasion by short term rates coming down and long term rates moving up at the same time. Over the next month, that trend is likely to get more pronounced unless of course, the rupee again turns volatile.
Bond yields have corrected sharply and the RBI has indicated the willingness to hold anchor when markets turn very negative. In such a scenario, markets are likely to be range bound, correcting with hawkish data points/news but finding support at lower levels drawing comfort on hope of regulatory intervention. Accordingly profit booking at higher levels and accumulating at lower levels seems most appropriate with last two week's high and low serving as the reference points.
Mahendra Jajoo is executive director and CIO - fixed income at Pramerica Asset Managers
