Benchmark yields to stay in 6.35-6.45% range

It was yet another week of record setting binge for global equities as moderate growth and accommodative central banking, dominated investor sentiment. European Central Bank (ECB) clawed back its perceived hawkish leanings as president Mario Draghi alluded tapering talks were not on the table yet and that set the tone for a broader risk-on mood.

The S&P index posted a historic high, US yields inched lower and the European single currency touched a two year high. Aiding investor sentiments was a plethora of factors like weaker dollar, a status quo on rates and easy monetary policy from both Bank of Japan and ECB.

European markets are laggards as stronger euro should serve to keep a lid on its asset classes. Dollar index is due for some correction and the coming weeks therefore should see some correction in global bonds and stocks. In another development of note, the UK government appears to be mulling accepting a proposal of free movement of EU citizens into the UK, a concession that may offset the business setbacks from Brexit. A positive indeed.

Indian bonds traded a narrow range, consolidating at recent highs. Insurance and Funds continue to be solid buyers. With global financial volatility having subdued and the unexpected possibility of a rate-change domestically coming so soon, that too a cut, bonds have been the most preferred asset class.

Poor credit off-take and humongous liquidity have been enablers in this liquidity driven rally - which is evident in the OMO sale last week where bid to cover was almost eight times. Both the OMO sale and weekly auction went off well with robust all round demand. Bond yields ended nearly flat with decent volumes on all days.

Late Friday evening, Reserve Bank of India (RBI) announced yet another OMO sale to be conducted on August 10. This is the third auction of such kind this financial year and what raises interest and speculation is its announcement some three weeks in advance. With RBI Monetary Policy Committee (MPC) meeting scheduled in-between (results on August 2), the timing of the announcement suggests if the policy announcement will carry more measures beyond an expected rate cut of 25 basis-point.

Taking the latest retail inflation into account, real rates are at about 4.5% and possibly amongst the highest in both emerging and developed markets. While this may not sustain, given the risks of mean reversal in food inflation and easing of demonetisation-led disinflation, the average is still far higher than RBI’s stated range and therefore the incidence of more than a solitary cut may be the expectation, atleast as long as system liquidity remains in glut-range.

The 10-year benchmark bond yield may find support near the 6.42% and move higher towards 6.50%. Ideally, an OMO sale news should drive yields higher, however, muted credit growth and expectations of rate-cut may cap any sharp rise in yields.

The US Federal Reserve meets later this week and no change is expected. Domestic bond yields should stay confined to a 6.35 to 6.45 range.

SHARP SPIKE

• The 10-year benchmark bond yield may find support near the 6.42% and move higher towards 6.50%
   
• Muted credit growth and expectations of rate-cut may cap any sharp rise in bond yields

The writer is executive director, Lakshmi Vilas Bank