Bullish momentum done for shift to bearish consolidation
India (old) 10Y benchmark bond 8.40% 2024 bullish momentum from over 8.65% got completed at 7.50-7.65% before push back to 8.0-8.02%. So is the new benchmark 7.72% 2025 which lost steam at 7.62-7.65% for reversal into 7.80-7.82%. The two main triggers are from squeeze in India-US 10Y yield-spread from over 6% to below 5.5% and higher probability of extended rate pause period through FY16. Given this operating dynamics, appetite for FY16 RBI bond supplies (to fund Government market borrowing schedule) will be low, when Banks are already to the limit on excess SLR looking for exit options, waiting in hope for RBI OMO bond purchases.
The guidance from 2nd June monetary policy is not positive. RBI is back at its balancing act to support growth momentum at 7.5-8.0% (against FY16 target of 7.6%) and cut inflationary pressure into 5.5-6.0% (against January 2016 target at 6%). Both combined, RBI has no bandwidth to cut rates till CPI target is reviewed below 5.5%. Till then, need to be prepared for rate-pause till end September 2015. Beyond here, CPI trend and FED rate hike stance will set the tone for way forward. So, it is safe to assume that Repo rate at 7.25% is there to stay through FY16, while staying prepared for surprise 25 bps cut in the unlikely event of soft CPI at/below 5% by September (before kick-in of base effect impact) and delay in FED rate-hike shift to Q1/2016. At this stage, keep expectation of 50 bps rate and/or CRR cut out of focus.
What next this week?
Given the strong headwinds from both domestic and external sectors, the short term outlook is not positive. US 10Y yield has already shifted trading range from 1.85-2.35% to 2.15-2.65%, and resultant squeeze in 10Y India-US yield-spread below 5.5% will cut FPI appetite against limited comfort on Rupee stability. It is less said the better on appetite of domestic investors. Both combined, the way forward is not bullish on the Gilts.
10Y bond 7.72% 2025 is seen in bearish undertone at 7.72/7.75-7.82/7.85% (8.40% 2024 at 7.92/7.95-8.02/8.05%). While 7.80-7.85% (old at 8.0-8.05%) seen as value-buy zone, it is not safe to hold at 7.72-7.75% (and 7.92-7.95%), given the risk of stretch into/beyond 7.85% (and 8.05%) on US 10Y yield stability at 2.40-2.65%. So, it is prudent to trade end to end of 7.75-8.05% (and 7.95-8.05%), rather than holding on to value-buy, given the low probability of gains beyond 7.72-7.75%; possible that 7.72% 2025 may not get into premium (yield below 7.72%) through FY16.
It is not good for India to lose investor appetite, which would increase the borrowing cost of the Government and pressure on fiscal deficit. It is unfortunate that RBI has limited bandwidth to go for the rescue. There are also noises from highly leveraged borrowers to cut rates, but it would be better for them to cut debt exposure to make liquidity available for incremental capacity-build.
Have a great week ahead; Good luck!
Moses Harding
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