Yields could hover around 6.80%; Big bond rally unlikely

It was a relatively calmer week for domestic markets. While equity markets continue to surge as a follow-through act of the major global indices, debt markets continue to slack in activity and yields firm and holding around recent highs.

First, the week saw release of Consumer Price Index (CPI) and Wholesale Price Index (WPI) for January 2017. While the headline consumer inflation came in a tad lower at 3.17% for January compared to 3.41% for December, 2016, the core inflation reading was higher at 5.09% versus 4.90% for the previous month.

Food inflation has considerably come off and the risk is that it could be transient. Core inflation tends to be sticky and in retrospect, RBI's decision to hold rates and turn neutral may appear justified. WPI at 5.25% was also far above the previous month's 3.39% and above expectations for current month. The spread between WPI and CPI at 208 basis now is the highest in last many months and proves the wider belief of demand destruction post the ban on scheduled bank notes (SBNs).

For banks, the process of demonetization will likely enable banks to create more credit and the money-multiplier effect could also be the fountain head of future inflation. IIP data for December, however, stood in stark contrast and came much below expectations and showed a contraction of 0.4%.

Currency markets were stable and the Indian rupee hovered below the 67 mark. Trade deficit provided relief and optimism that the rally in commodity prices is feeding into rising exports as India registered a straight fifth month of exports growth.

Monthly trade deficit narrowed to $9.75 billion and barring sharp rise in prices of crude, the overall trade data is positive. Rupee is likely to stay somewhat decoupled with the dollar's strength in the shorter run as strong foreign direct inflows (FDI) flows should act counter. As data shows, FDI in India jumped close to 20% in calendar 2016 and, with improving fundamentals, this should sustain.

Bond markets breathed a sigh of relief as the week did not have the regular G-sec auctions. An SDL auction midweek and a surprise bond buyback were both positive for markets in terms of cut-off. They rendered the overall liquidity position neutral and the system is still surplus in excess of Rs 3.5 lakh crore. Corporate bond yields have been showing firming up tendencies in the last few sessions and this could be the first symptoms of RBI's policy intent feeding into prices.

In overseas markets, major equity indices continued their stellar advance on growing evidence of US economic growth and rebounding inflation. Major US indices again notched record highs during the week, though bond yields held steady.

There is however, a cloud of uncertainly from the European quarters as the International Monetary Fund and Eurozone finance ministers remain at odds over the direction of the Greek bailout and its procedures. With major elections coming in the second quarter in Netherlands and France, market hopes there will be an agreement where Greece gets its euro 7 billion bailout package. In other event, Yellen's testimony continues to suggest the hurry in a US tightening and much of that will get support in the coming weeks if US data beats the estimates.

Indian bonds may continue to trade in ranges with pivot at 6.80% for the benchmark bond. Not many drivers to support a big rally in the near future.

The writer is executive director, Lakshmi Vilas Bank