Long tenor bonds may see aggressive selling

A G3 chorus that appeared to be signalling an end to the easy regime of liquidity glut and lower interest rates and a surprise happy ending for the domestic bond markets for Q1 characterised the bygone week.

US Treasury yields finished the week near six weeks highs as government bond sell-off continued in both Europe and the US on the back of hawkish comments from the heads of the respective governments. The trigger came first from Federal Reserve chairperson’s comments that asset valuations are “somewhat rich”. This was followed by hawkish comments from Mario Draghi, the ECB president. Bank of England also joined the orchestra calling for caution over inflationary concerns and a need to plan for rate hikes. US data showed personal income growth remained robust alongside a robust PMI reading – overall the central bankers in G3 risk walking the talk to end the decade-long regime of ultra easy liquidity and lower interest rates. In this medley of firming rates, US dollar touched an eight-month low against majors. In the short term though the dollar weakness should persist before a strong rally commences.

The Indian bond street had every reason to stay cheerful as yields closed near the lowest level for the quarter in a strong reversal of sentiment. At the start of this quarter, it appeared bond traders were contending that the rate-cut cycle in India was over and a longer pause would ensue before rate hikes. However, the June Policy and MPC statements/minutes betrayed such apprehensions and bonds have rallied handsomely. With both CPI and core inflation way below Reserve Bank of India's (RBI) guidance and estimates, the bond prices have virtually priced in a possible rate cut in August. While RBI is theoretically targeting neutral liquidity, the large and persistent hangover of excess liquidity in the system suggests RBI may be taking a pro-growth stance and is showing less urgency in moving to that neutral target. This has been somewhat positive contributor to the last leg of the bond rally in recent weeks.

In other developments, the Union Cabinet announced minimum support prices (MSP) for kharif crops. With food inflationary appearing to fall into a deflationary spiral, MSPs will go a long way in reversing this trend.

RBI conducted an 80-day cash management bills (CMB) auction during the week. Along with a decent bid-to-cover ratio in the Friday auction accompanied by higher volumes, bond yields ended the week marginally higher than the recent lows. The late-evening announcement of open market operations of Rs 10,000 crore of dated securities may end up being interpreted as “setting a cat among the pigeons” and this may be perceived as somewhat hawkish of an action. While it should be seen against the large bond redemption in the week ahead, one may prefer to err on the side of caution and therefore square up or defer buying decisions.

Benchmark 10-year yield may move towards 6.60% from current 6.51% and long tenor bonds may see some aggressive selling.

...& ANALYSIS

• Along with a decent bid-to-cover ratio in the Friday auction accompanied by higher volumes, bond yields ended the week marginally higher than the recent lows
   
• The late-evening announcement of open market operations of Rs 10,000 crore of dated securities may perceived as somewhat hawkish of an action
   
• While it should be seen against the large bond redemption in the week ahead, one may prefer to err on the side of caution and therefore square up or defer buying decisions