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Fixed income market stabilised this week, recouping some of the losses of last week. While the new benchmark 7.16% 2023 yield remained unchanged at 7.24%, yields for other parallel bonds as also for corporate bonds closed marginally lower by 3-4 basis points. Liquidity showed some improvement with LAF borrowing coming around Rs 55,000 crore.
The sentiment recovered following an unexpected open market operation announcement, although for a lower amount of Rs 7,000 crore rather than the usual Rs 10,000 crore and with final fiscal deficit for FY13 reported at 4.89%, much lower than the revised budget estimates of 5.1%. Readers will recall we mentioned possibility of resumption of OMO in last week's note, given the required intervention in currency markets.
RBI also announced further restrictions on gold imports, thereby raising hopes of some improvement in the deteriorating current account deficit situation. Money market rates eased more meaningfully by 10 bps due to strong demand from mutual funds and improved liquidity.
Markets traded very firm in the first half of the week on the back of these developments. However, the rupee continued to depreciate through the week eventually closing above the crucial 57 mark for the first time in more than a year.
In fresh comments, an RBI deputy governor said that it would look at factors other than WPI inflation also for monetary policy. The RBI governor also reiterated that consumer inflation is still high and the current account deficit is under stress. Market sentiments turned weak thereafter with bonds giving up most of the gains in the later half of the week.
This part of the month is typically data heavy and the last two have been especially cheerful for fixed income with a sharp decline in inflation. Analysts expect both the WPI and CPI inflation to be sharply lower yet again. However, a depreciating rupee and a risk-off mood in global markets will possibly dominate the space. The current account deficit figure, to be announced this week is expected to be sharply higher given reports that gold imports in May were 162 tonne vs 140 tonne in April. The rupee may also scale a new all-time low, possibly closer to 58 mark this week. That could keep the sentiment subdued. A sharp spike back to above $104/bl in crude oil prices in Friday trading in US will also keep traders nervous.
RBI will announce the next policy review on June 17 and the market is already beginning to discount the lower expectations of another rate cut. However, one cannot completely rule out the possibility of a rate cut yet. Further, given slow growth, better than expected progress in fiscal consolidation and most importantly a timely onset of monsoons, hopes of rate cuts in subsequent policies still remain. Accompanying comments in policy review will thus provide guidance for future course. A non-committal statement may spook the market to set tone for a deeper correction. At this point, a conservative positioning for better valuations looks appropriate.
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The author is Executive Director & CIO - fixed income at Pramerica Asset Managers
