Risk-off support from Brent Crude
US 10Y Treasury yield eased into 1.90-1.95% from consolidation zone of 2.20-2.35% on set up of panic on Brent Crude extended fall below $50 before stability at 50-53. This was followed by outlook of FED preparedness for shift to rate-hike cycle by mid 2015 and ECB preparedness for next dose of liquidity injection. All combined, guiding yield stability at 1.95-2.05%. While there is good clarity on FED/ECB monetary policy stance on the way forward, outlook on Brent Crude is mixed but with reasonably good confidence that stability at $50-65 will be established soon. All taken, short term outlook is for stability at 1.90/1.95-2.20/2.25% with upward bias ahead of expected FED rate action by mid 2015. The strategy is to play end-to-end and it will be high risk to stay invested at 1.90-2.0%.
Domestic optimism versus risk of dilution in FII appetite
India 10Y bond yield is rock-solid at 7.85-7.90% on cross winds. Domestic cues are in favour on dilution of long term risks from twin-deficits on growth-inflation dynamics. Expectation on CAD is solid for sharp trend down into 0-2% on long term sustainability of Brent Crude at $40-65, while inflation worry is behind with no major risk from base-effect impact or supply-side bottlenecks. There is minor worry (and risk) on growth from execution delay, while achievement of fiscal prudence to create space for public investments is distant away. With significant dilution in Rupee risk (on interest rates and inflation), it is the best time for RBI to trigger 50 bps rate-cut now or soon; there is no strong case to delay any further! The concern however is from FII appetite going forward and extent of domestic appetite from Banks, who will be in unwind mode of huge excess SLR book to release funds for build-up of Credit and Corporate investment portfolio to meet higher demand. All combined, there is strong support at 7.90-8.0% but don't see bullish momentum beyond 7.65-7.75% given the shift of operating policy rate from 8.0% to 7.5% with 50 bps rate-cut followed by extended pause. All taken, short term pre-rate cut range is firm at 7.80/7.85-7.90/7.95%, preparing for post-50bps rate cut range to 7.65/7.75-7.85%. The strategy is to stay invested at 7.85-7.95% for exit at 7.65-7.75%, thus completing the 1% chase from 8.65% 7.65%.
Ease in India-US bond spread will reduce FII appetite
Foreign investors have been happy to play over 6% carry-trade advantage between India-US 10Y bond spread, which is now down at 5.65-5.90%. The contradictory monetary policy stance between FED (baby-steps rate hike mode) and RBI (one-shot 50 bps cut and pause thereafter) will squeeze the bond spread below 5% by end of 2015 on India 10Y bond yield stability at 7.65-7.80%; sustainability here is dependent on Rupee exchange rate stability and long term CPI stability at lower end of 4-6%. This risk will shift FII appetite from India to elsewhere.
Stable outlook with more downside risks
Combining the domestic and external dynamics in play, short term outlook is for stability in 10Y bond at 7.70-7.95% while not ruling out downside risks beyond 7.95% with worst case not beyond 8.15-8.40% on accelerated FED rate-hike (driving US 10Y yield into/above 3%), and stubborn India CPI at higher end of 4-6%. It is good to keep this in mind and retain immediate attention at 7.65/7.70-7.90/7.95%.
Moses Harding
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