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According to Vikas Gupta from JPMorgan, the possibility of yields going back to 9% cannot be ruled out.
He believes that further open market operations could help bring yields down, and that a rate cut will see yields fall to 8.25% levels. ďBut if RBI action happens on the CRR front, then definitely we will see the short end coming off much more than the longer end,Ē he said.
Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video.
Q: Whatís the view in the bond market ahead of the next policy in terms of where yields may range between?
A: I think the key event which market will be watching out for even ahead of policy would be the auctions. We will have the fresh borrowing program starting in the first week of April and so far OMOs have been supporting the market and we saw that the yields move down from 9% to 8.15% and now they are at around 8.40%.
Our expectation is that once the fresh supply hits the market, we should see 10 year bond moving to say something like 8.60-8.70% kind of level where it should stabilize. I think thatís the level probably where we will see some demand. Given the fact that market will be little bit optimistic about the policy, I think thatís the level where market will initially be willing to absorb the additional supply.
Q: Just in case we donít get that April rate cut, do you think itís a possibility that yields head back to close to 9% again?
A: I think itís a fairly distinct possibility, because we have been making this argument earlier also that with the funding rate at 8.5% and banking systemís current SLR at around 30%, I donít think there is any incentive for the banking system at least to absorb additional supply at 8.5% if the funding rate is also at 8.5%.
I think banking system will definitely be looking at some kind of yield pick up over the overnight funding rate, so I would say 9% is not really something which cannot be ruled out.
Q: Say the auctions in early April are pretty much along expected lines and then you do get a 25 bps rate in April, what do you think the yield can cool down to max?
A: Once we see a rate cut in April, we move down to 8.25%, then essentially I think itís really a data dependence story. Market has been talking a lot about oil prices, hike in administrative prices of petrol, diesel and we will see indirect tax hike also coming into play. So the inflation will also I think start presenting a different picture. So I would say itís going to be a very, very data dependent kind of story from thereon.
Q: What if things move in a slightly different direction in the sense that the RBIís focus of action remains on liquidity environment? More OMOs, working to reduce the CRR more but not working on the key rates. What kind of impact would that have on yields?
A: That can result in steepening of the curve. If it is happening through OMO route, then definitely the 10 year bond gets impacted and yield comes down. But if the action happens on the CRR front, then definitely we will see the short end coming off much more than the longer end. So it will depend on which instrument RBI chooses to act on the liquidity front.
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