Consolidation phase on mixed cues
10Y bond yield in sideways mode at 2.15/2.20-2.35/2.40% on lack of clarity on the way forward, hence the back-and-forth mode without enough momentum on break-out either-way. There is not enough clarity as yet on the timing of shift into rate-hike cycle; opinions differ from 1H/2015 or 2H/2015 or 1H/2016 with most in expectation of extended pause till end of 2015, thus attracting investor appetite at 2.35-2.40%. On the other side, better than expected economic data print build risk of staying invested at 2.15-2.20%; this kind of back-and-forth moves is trader's delight but pain to long-term strategic investors. The other factor that add to bullish rhythm is on investor shift to risk-off stance on exit from high-valued equity assets, with loss of appetite at 2.15-2.20%. All taken, there no major cues to trigger break-out of 2.15-2.40%, but do not rule out extension below 2.15% on pressure on equity market. However, any sign of hawkish guidance by FED on improved confidence on growth and unemployment will get the focus back into 2.35-2.40% but not beyond here on excessive global liquidity at near-zero interest rate. Retain long-term outlook at 1.90/2.15-2.40/2.65% while staying neutral on break-out either-way!
India Gilts firm on risk-off and low credit demand
India 10Y bond extends gains below 8% into 7.85%, thus building expectation of 50-75 bps rate cut sooner than later. Adding to this bullish expectation, Banks (and other investor/lender entities) do not know what to do with the money when there are few acceptable credit risk opportunities giving decent return. The beneficiaries in this environment are the Government and AAA/AA corporate entities. Government benefits from lower cost on fresh issuance while the low credit risk entities are able to borrow at very low premium over sovereign yield. The hit is on retail investors and relatively high risk borrowers. Bank retail deposits are at par or lower than sovereign yields across all tenors, while sub top-notch borrowers struggle to source funds at affordable cost. Now, the stake-holders pressure on RBI for rate-cut extends to political parties taking on the Governor for not doing so! While the rate cut is seen to be round the corner, the beneficial impact will be limited and may not be surprised to see post rate-cut sell-off if the tone is not positive and seen to be done under pressure; political pressure on RBI for rate action is not a good signal to be sent to global investors and rating agencies. There are many cues for and against significant move either-way from current levels. The major triggers are from the FED (on timing of start of rate-hike cycle) and exit options to huge excess SLR, which has to be either absorbed for incremental deposit growth or has to be unwound when credit demand pick up; risk from Rupee exchange rate is also in the radar. There is now better comfort on the inflation despite base effect impact and other factors relating to supply side pressure and outside chance of sharp reversal in commodity prices. All cues taken, there is not enough space for sustainability in 10Y bond yield below 7.85% and there is no major risk for weakness over 8% if unwind of excess SLR is aligned to baby-steps rate cut. So, given the mixed cues in play, it is good to stay focused at 7.85-8.0%, being neutral on break-out either-way. There is also need to align India 10Y bond with US 10Y at 5.50-5.65% to prevent run on Rupee. This stance is valid till inflation expectation ease into lower end of 4-6%. The strategy is to stay invested at 7.95-8.0% and be fleet-footed at/below 7.85%.
Moses Harding
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