Yields may rise 7%; US data key focus for markets

Another eventful week went by which saw the US Dollar saw broadly lose ground to major- and emerging-market currencies; treasury yields firmed and equities recovered after a brief sell off.

First, the French election results threw some surprises in the first round of polls. The less-favoured centrist Emmanuel Macron advanced to the final round edging out Le Pen and the final round on May 7 would hold key to the future of the French. The rally lifted the MSCI World Index to an all-time high on Wednesday. US Treasury yields backed up to 2.31% from a low of 2.16% the previous week. That set the tone for risk-on trade, further getting a boost from the Wednesday Trump-tax announcements.

Corporate tax rates have been sharply taxed in the US and a congressional approval should pave way for a strong rebound in the US economy. Perhaps, this was at the back of market participants' minds- which is why a sub-par GDP data did not dent market confidence much. US GDP for Q1 grew by a pigmy 0.7% when broader market was expecting close to a percent of growth. Statistically, this is the slowest quarterly growth in eight years. Main Street analysts attribute to temporary drop-off in consumer spending, a typical winter effect, and it needs to be seen how this sedate start would influence rate decisions.

In other developments, both Bank of Japan (BoJ) and European Central Bank (ECB) kept rates unchanged. In a surprise move, ECB also appeared to be less dovish and more unlikely to set off the tapering of quantitative easing. Libya supplies hit the crude market which led to softening of global crude prices

The major redeeming feature for Indian markets was the strengthening of the rupee, which now has gained nearly 5.50% in calendar 2017 and is at four-year highs. Strong flows from foreign funds, betting on the likelihood of India remaining the best emerging market over medium term, has contributed to this unidirectional rupee move. Sensex scaling and closing at historical highs put Indian asset-classes in spotlight. While the rupee may have more strengthening to come over medium term, there strongly appears a short-term correction being due.

Bond markets and Indian fixed income traders had little to cheer about as benchmark 10-year bond yield is menacingly inching towards 7%, shrugging off the humongously large systemic liquidity and foreign fund flows. The reasons for this bearish outlook arises from the recently released monetary policy committee (MPC) minutes where one of the members appeared to be veering towards a rate hike but moderated his stand in the final vote. The consensus fear was the likelihood of sticky and high-core inflation, which in the collective opinion of MPC members warranted a hawkish treatment. A longer pause and removal of the overhang of excess liquidity will be the first step, which should take a couple of quarters. If monsoon does not disappoint, inflation concerns could abate.

The regular weekly auction saw good response with a bid to cover of 3.28 times. Yields rose by a few basis points post auction cut-off. The week ahead should be no different, a test of 7% should not be a surprise. US Payroll data would be a key data point to focus for both domestic and global markets.

The writer is executive director, Lakshmi Vilas Bank