Benchmark bond yields may remain in 6.65% - 6.80% range

Financial markets had another cheerful week as equity indices touched record highs in Europe and India while bond markets remained somewhat flat. There, however, was hints of caution as earnings season kicked in.

The US Federal Open Market Committee minutes contained no surprises while Catalonian crisis showed signs of receding. US Federal Reserve looks almost certain to hike in December albeit data shows fewer signs of inflationary pressures.

Minutes from the September meeting of the FOMC showed that a majority of the voting members considered another rate hike this year was more likely to be warranted if economic outlook remained unchanged.

However, some members expressed concerns that recent soft inflation data may not be temporary for idiosyncratic reasons and therefore the next few months of data would be critical. US retail sales showed pick-up, boosted by auto sales and higher gasoline prices, one of the fallouts of recent hurricanes. The 10-year US Treasury note receded to 2.28% from 2.38% a week ago. Oil recouped some of its recent loses while precious metals corrected lower on profit-taking. European markets breathed a sigh of relief as the Catalonian talks progressed well while an impasse in Brexit related uncertainties provided some support to sterling pound.

Domestic equity markets had their moment of glory as the 50-stock Nifty index touched another life-high. Bond markets also found some support as the Indian benchmark bond yield retraced to 6.72% from close to 6.80% early in the week. The rupee strengthened and broke below the 65 mark as a stronger industrial production data alongside a lower-than-expected Inflation data spurred market sentiments.

The Index of Industrial Production data for August showed a rise to 4.3% as against a growth of 1.20% in July (which has been downwardly revised to 0.9%) as companies stepped up production in preparation for the festival demand. This could be initial signs of demand-driven economic activity picking up. The more keenly watched Consumer Price Inflation for September showed a reading that was below market expectations. Headline inflation of 3.28% came in much lower than median estimates of 3.53%, while core inflation climbed to 4.6%, suggesting the drop in headline inflation would not translate into any meaningful signal for Reserve Bank of India to veer towards a policy shift.

However, given the likelihood of undershooting of macro forecasts, one could expect a longer pause and a neutral stance on liquidity. There is some amount of ‘supply-discount’ building in at current levels of bond yields which would abate as new data and an on-course borrowing programme runs its course. High yield bond spreads could compress as investors move in search of returns with a stable currency and neutral to slightly positive liquidity play out.

Benchmark 10-year bond yield should remain in a 6.65% - 6.80% range as festival led holidays dot the week.

SUPPLY DISCOUNT

• There is some amount of ‘supply-discount’ building in at current levels of bond yields which would abate as new data and an on-course borrowing programme runs its course
   
• High yield bond spreads could compress as investors move in search of returns with a stable currency and neutral to slightly positive liquidity play out

The writer is executive director, Lakshmi Vilas Bank