Bond yields to remain in 7.20 -7.35% range

The penultimate full week of calendar 2018 had its share of surprises for the markets. In what could be seen as a pre-Christmas event for savers, the Federal Open Market Committee (FOMC) of the US, hiked key rates by 25 basis. That was broadly expected. What was not expected was that the committee did not turn dovish as the trading community had widely expected. It maintained dot plots at two as against the hitherto three, which was a much widely expected move.

The disappointment was in the fact that most in the financial markets expected it at one. Equities fell sharply, the world over. Yields on the US key benchmark yield fell to 2.79% in spite of the hike. Crude prices fell by about $6.50 during the week to end the week at $46, which is the lowest since the summer of 2017. VIX (the CBOE's volatility index) rose during the week and ended at 27.6. The week ahead could witness thin trade in holiday markets and apart from sharp moves and extreme volatility due to Christmas holidays, there is nothing much ahead for the week.

During a week when Sweden's Riksbank raised rates by quarter percentage point after seven years, the US Federal Reserve also raised rates and markets were pressured by less-dovish-than-expected US FOMC. The relative absence of concern on the part of Jerome Powell surrounding the recent downdraft in risk markets spooked equities which tumbled to its lowest point in 2018. Scant evidence of inflation had made investors expect a statement of policy error in aggressive tightening by the Fed Chair but he continued to maintain his bullish expectations. That the Bank of England and Bank of Japan held rates steady, largely on growth concerns well explains why markets must have been disappointed.

In other developments, China moves to support its economy as it moved from employing a decade-long practice of targeted stimulus to announcing significant tax and fee cuts and promised to ease monetary policy alongside. The US Q3 GDP was revised lower and focus now shifts to Q4. Economists expect a slowdown.

Indian bond markets had its best run for FY 2019 as the benchmark yield continued to hover around 7.20s for a long while. Minutes of the December Monetary Policy Committee (MPC) suggested the members were still preferring to remain cautious and it will be a data-driven MPC. The larger surprise though was an increase in open market operations (OMO) purchases by the Reserve Bank of India (RBI) for December 2018 and announcing an equally larger purchase calendar for January 2019. The announcement from RBI states it will purchase Rs 50,000 crore in January and it could well be the same for the other two months of Q4.

The overall purchase under OMO now likely stands at 80% of the borrowing calendar and is a statement indeed, that underlying liquidity conditions remain more fragile than one thought. With currency in circulation and liquidity from forex operations not likely to impact much, the OMO spree is here to stay for some months at the least. Bond markets have relished this liquidity-driven rally and should be one of the best quarters after 2017 for institutions.

The benchmark 10-year should remain in the 7.20 -7.35 range in a holiday-thinned market ahead in the coming week.

ON STRONG FOOTING

• Indian bond markets had its best run for FY 2019 as the benchmark yield continued to hover around 7.20s for a longer while
   
• Bond markets have relished the liquidity driven rally and should be one of the best quarters after 2017 for institutions

The writer is a market expert