Jayesh Mehta of Bank of America says the Federal Reserve's statements will play a huge role in the July rate cut decision of the Reserve Bank of India (RBI). The two-day FOMC meet starts tonight.
After the RBI maintained a status quo on its credit policy on Monday, analysts have been debating on the chances of a rate cut in July. Speaking to CNBC-TV18, Mehta says the Federal Reserve's two announcements before the July 30 rate cut will play a key role in the decision of the RBI.
Meanwhile, he believes that selling-off by the foreign institutional investors in the debt market has come down in the past one week. He sees the 10-year government bond yields coming down in the second half of July. On currency front, Mehta believes that rupee will stay volatile and that is why people are running short positions on the Indian currency.
Below is the verbatim transcript of Jayesh Mehta's interview on CNBC-TV18
Q: At 7.25 percent, what is the 10-year bond yield currently pricing in? A rate cut or a no rate cut in the July policy?
A: Currently, the bond market is not really pricing anything, it has stabilised. On Monday also, the yields came down sharply, and it was mainly because of virtually very low positions with traders whatever the supply, either primary or whatever, has been sold by the foreign Institutional Investors (FIIs) has been absorbed well by the local banks in large ways in the past 15 days.
So at this juncture, it is not pricing either a rate cut or a rate hike. People are looking forward for a fair statement on Wednesday and after that people may take some call on whether rate cut in July will happen or not.
Q: There are a lot of people who don't think that July is ruled out. Where do you stand and therefore, how will the bond markets move with or without a rate cut?
A: Before our July policy we will have two Fed statements coming in, one on Wednesday and one in July. This whole month particularly till end of June as expected earlier, we will see volatility on both sides. Till yesterday, people were talking that maybe emerging market sell off is over and even if the tapering is going to happen it will happen sometime between September to November.
The rate hike in the US is not going to happen immediately, so maybe it is over sold situation. People were expecting that on June 19, Fed may be a bit dovish. Last night, we had some news editor giving out and people are again scared that Fed would be tapering it very soon. So this kind of situation is going to happen at least for sometime till people’s portfolio really get adjusted to a comfortable level till mid-July. So, we should see some stability coming in but in the second half of July, we would see bond yield coming lower. Hoping nothing dramatic really happens on the US side.
Q: What happened in the currency market on Monday? We saw the equity markets rally quite a bit but the rupee gave up its intraday gains and closed weak.
A: For rupee the same thing is happening. When the May 22 statement for the Fed came and before that the dollar was having a bit of strengthening against all currencies. Then the second axe fell on the emerging market and we did suffer with the emerging market as well. Since yesterday, the countries where the current account deficit (CAD) is higher, are getting hammered. So India, Brazil, South Africa are getting little hammered against dollar.
When you don't have any view, it is all dependent on how the Fed statements are going to be and so, at this juncture people are just looking at the technical. May be the previous 58.60-58.70, if it breaks, people may come to buy dollar more and that could accelerate the depreciation. As of now, it looks like it is holding up but it is going to be volatile. And that is the reason people are also running very light positions. There is hardly any risk in the market to that extent but we have to really watch out completely on Fed.
Q: Do you think we are still vulnerable to the kind of savage fall we saw from end May to mid June on the currency front?
A: Since I am little more passionate about bond markets, so I want to clarify one thing. We all have been talking about hot money and especially associating hot money with bond market. If you look at the sell off of the USD 3.5 billion that happened from May 22 till June 10 or 11, in debt unlike equity, at least 75 percent of the investments are hedged. 25 percent could be open positions. To that extent, its impact on currency is not much.
There were people and even the exporters did sell off at 56 that was the first trigger because of gold and everything. April-May was looking very nice and nobody expected the Fed statement on May 22. So there were some short dollar positions in the market and people sold and their exports sold as well. After this fall started happening, people got completely spooked up.
Even right now, we don't see exporters coming to sell. They just allow it to settle and that is when we will come in. So, people are waiting on the sidelines, they are not coming to sell and there were some positions that got reversed. To an extent, the fall was little larger because some positions got reversed. However, can we rule that out completely? I would say no, because we haven't seen huge outflow on equity yet.
I don't think something dramatic may happen for the Fed, but if something dramatic happens and the US yields shoots up and everybody thinks that tapering will happen faster and the emerging markets start withdrawing, if we see large equity outflows which is un-hedged positions, that could create a situation. But I am just putting 3-5 percent probability on that and will not completely rule that out.
Q: We know about USD 3.5 billion is being sold by the FIIs in the debt market from May 22 to June 10. In the last one week, what has been the activity, have we seen such similar selling by the FIIs in the debt market or has it calmed down? Do you have any figures?
A: Yes, it has calmed down dramatically. When the withholding tax announcement came, I was quite bullish on that but at least that money, the new investors to start and set up their internal process it is going to take at least three-four months for them to start investing into India. Even right now, one of the clarifications on corporate bond, on withholding tax is still not there. One notification is still missing.
Once you have that, people will start their process and it will take three-four months to actually then start to invest in India. They will look at it whether it is worth or not but at that point of time, from May 1 to May 22, if you look at it did the new FIIs buy, not really. It is the existing FIIs, traders who actually bought thinking that the new FIIs will come in with the withholding tax coming in. However, when the Fed statement came in that is the position sell off that really came in.
Q: Can you give us the bond range that you are expecting? You said yields can start falling in the second half of July. What kind of yields will you play for?
A: I would still target 7.10-7.05 on the new 10-year but it all depends on the Fed statement. As of yesterday, there was a feeling that even if the Fed tappers off it would be late 2013 or early 2014. Even the rate hike is not going to happen before 2015. So from that perspective, I am looking at that scenario. If anything changes in that and from RBI’s perspective they said in the last policy, it also depends on the external factors. They were more focused on GDP and inflation but they warned on the external factor and to that extent even they would like to see what it is doing before they take a final call.