Yields to move towards sub-7.25-level

The first full week of calendar 2019 brought in positive sentiment to markets as equities moved higher, crude prices bounced back from December lows and Treasury yields also inched up amid the continuing partial shut down of the US government offices as a defiant Trump refuses to relent. 

Volatility remained tad subdued as evidenced by the drop in the CBOE's Volatility index. Lastly, some progress on the US-China trade talks has been reported.

Indian markets remained active as the rupee continued to gyrate within a larger range. Bonds remained weak as lower appetite and fears of fiscal breaches haunted back. The volatility in IIP data series continued as the latest release showed a shocking contraction with headline growth of half-a-per cent. 

Overseas markets breathed easy as minutes of the December meeting of the US FOMC showed that a large number of voting members expressed the view that in an environment of muted inflation pressures, the committee could afford to be patient about further policy firming. Reaction thereafter from markets suggest the odds of a hike before May 2019 are low now, although inflation is expected to be steady and closer to Federal Reserve's 2% target. However, continuing above-trend growth and a resumed decline in the unemployment rate would mean that at least two quarter-point rate hikes are still likely in the latter part of the year.

In other market events, a no-deal Brexit looms large and portends yet another set back for Theresa May, the British Prime Minister. The risk is of an early general election in the UK. European economy continues to falter as Industrial Production data from Germany and France showed a sharp fall. Rate hikes post withdrawal of asset purchase program may be a distant event, therefore.

Indian markets had a brisk second week of the new calendar year. While equities had mixed fortunes, bonds resumed their once-too-familiar weakness as benchmark yields moved above 7.50% defying underlying positives. Sell-off appears to be a default reaction in the domestic bond market as the latest firming up of crude prices dampened sentiments. Real rates are far too higher in comparison to other emerging markets and the risk from higher inflation would remain a low probability factor. The week saw the launch of the new 10-year benchmark paper which went with a coupon of 7.26% as the cut-off. With headline inflation and broader market indicators better than the previous year, one expected the cut off to one below the on-the-run benchmark.

IIP data release showed factory output growth slumped to a 17-month low of 0.5% in November 2018, plunging from 8.5% in the same month of the previous year. October reading was upwardly revised and the latest slump raises the question if the economy is indeed back on rails. Manufacturing continues to be a sore-point and begs the question if it is credit support that is missing or is it demand destruction. It could have been partly due liquidity factors that may be affecting auto sectors and lower rural spending, but the worries remain.

Market participants will be keenly looking forward to the inflation data being released this week. Yields are attractive at current levels and a slow and steady move towards sub-7.25 in the 7.17 benchmark bond should be a fair expectation.

The writer is a market expert

INFLATION EYED

• With headline inflation and broader market indicators better than the previous year, one expected the cut off to one below the on-the-run benchmark
   
• Market participants will be keenly looking forward to the inflation data being released this week