Yield curve may steepen further

For once the much clichéd trade concerns between the US and China took a back-seat in the past week. The US Federal Reserve's change of stance and India's stand-in finance minister's Interim Budget that was on expected lines, was the cynosure of the financial markets. The global equities rallied on the week partly due to a dovish US FOMC. 

Bond yields inched lower, volatility, as measured by the CBOE's VIX, declined, the US dollar lost ground to most major currencies as commodities and precious metals rallied.It apparently looked as if the US Federal Reserve corrected its December mistake as the central bank's policymakers seemed to dart out of their way to course-correct after sending a more hawkish-than-intended signal to markets after their last meeting in mid-December, which was followed by a slide in stocks and a spike in credit spreads. 

The Federal Open Market Committee (FOMC) unequivocally indicated that its next move could be either a hike or a cut, a shift from signalling further hikes in each of its policy statements for the past several years. Additionally, the chairman of the rate-setting committee said that the case for additional interest rate hikes had weakened in recent weeks while downplaying the likelihood of a significant uptick in inflation. And what followed in the data release was a bit of a surprise shocker to the policymakers.

Nonfarm payroll surged to a whopping 304k jobs for January while the unemployment rate ticked up and November's number was sharply revised downwards. The economic landscape is somewhat murky yet. In other developments, the UK Parliament voted to renegotiate Brexit while the European Union said an emphatic "No"Indian markets had more to chew as the Budget for FY20 was presented by the finance minister. 

While this is still an Interim Budget in view of the upcoming general elections, it carried enough bite to shake markets. Key among the takeaways was that for the fourth consecutive year, the Indian government appears to have given a go-by to fiscal deficit targets and the road map to a target of 3% looks more like a trudge than a smooth transition. The gross scheduled borrowing number at Rs 7.1 lakh crore is higher than market consensus expectations and combined with state and the PSU borrowings, bond markets will likely start pricing in the risks of crowding out. 

The announcement of additional borrowing in the current fiscal was enough to spook yields and sour sentiments. At a time when the Reserve Bank of India (RBI) has professed to manage liquidity deficit with steady open market operations (OMO), the fresh supply will add to the concerns.

With RBI's monetary policy committee (MPC) slated to meet this week, it is probable that the committee looks at the budget with some hawkish lens as it not only fails to adhere to consolidation but aims to provide a consumption-led stimulus which could have inflationary overtures. The only comfort for the local markets come from the fact that the US appears to be a crying halt to its tightening regime and China is up with fiscal stimuli programs.

Bond spreads are already wide to warrant further sell-off. The curve could steepen further as the short end of the rate curve will be anchored by liquidity and long end by uncertainty. Benchmark yield should start pricing in a policy shift and would be a good buy at current levels.

SHIFTING FOCUS

• Benchmark yield should start pricing in a policy shift and would be a good buy at current levels
   
• When the RBI has professed to manage liquidity deficit with steady OMO, the fresh supply will add to the concerns

The writer is a market expert