Expect 10-year bond yields to be around 8-8.5% in Q4: HSBC

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Manish Wadhwan, director and head of interest rates at HSBC, tells CNBC-TV18 that he expects bond yields to be around the 8-8.5% level till the end of the fourth quarter. "I think the market got used to the open market operations (OMOs) on a weekly basis, but we don't expect the RBI to conduct more OMOs during the quarter," he said.

However, he says this is subject to any additional needs of the fisc. "If they are not able to meet their disinvestment target or they need something extra, then you may see some kind of an OMO announcement," he said.

The bond market yesterday saw a lot of volatility after the CRR cut surprised the market. Yields slipped as low as 8.03% immediately after the policy, but rose to 8.35% by end of trade.

Wadhwan goes on to say that he expects the RBI to cut another 50 basis points on the CRR front in the month of March. "The repo rate will change in FY13 and it will be cut by 100 basis points," he added.

Below is an edited transcript of his interview with Latha Venkatesh and Ekta Batra. Also watch the accompanying video.

Q: In forth coming weeks, the RBI governor said that if there is a liquidity issue, OMOs will continue. So why is the market sulking?

A: First of all, the policy yesterday was quite pragmatic and quite balanced; they are balancing concerns on inflation and the growth concerns equally. From that point, coming back to bond markets, you will have to look at the perspective of what has happened in the last two months. We were hovering around 9% yields on the ten year bonds two months back, but OMOs by the RBI has helped bring down yields to 8.15% levels. I think the market got use to the OMOs on a weekly basis because the RBI has bought back Rs 72,000 crore in the last one and half months.

In addition to that, the bonds being bought by FIIs in the last one, one and half months also added, so the net situation was that the market was not getting any supply. I would not say it is a sulk, but an adjustment because it is a Re 1 fall after a Rs 6-7 rally.

One point which I would like to raise is that the government increased their borrowing number by Rs 93,000 crore for the year on the dated side. RBI has already bought something like Rs 72,000 crore, so we are somewhere near the completion of this OMO buyback also. If you see the last four years numbers, they have been hovering between Rs 65,000-85,000 crore per year to adjust for the base money. I think what has happened may have spooked the bond market a bit, but on a big picture basis it really did not make any big difference so I would say.

Q: How would you play the markets over the next eight weeks or so of this current fiscal? What are your expectations by way of OMOs from the RBI and what is the trajectory for the bonds itself up until March 15th the next policy?

A: On a base case scenario, I would expect 10 year bond yields hover between 8.25-8.5% within this quarter, basically till March 31. On the OMO side, the base case scenario would be that RBI may not be conducting any further OMOs in this quarter subject to any additional need from the fisc. That is if they are not able to meet their disinvestment target or they need something extra, then you may see some kind of an OMO announcement, but I would say that probability would be lower because

I would expect RBI may cut another 50 basis points of CRR in the month of March. This is coming from the fact that we have seen the overall money market getting tighter and the structural liquidity getting into more deficits. I think there are two big reasons for that. One is the RBI intervention in the forex markets and second thing is the more than expected currency with public outflow from the system during this quarter, the last two weeks numbers suggest so. To balance that out I would say the first probability would be further CRR cut in March and if any additional borrowing is required by the government because of some kind of adjustments on disinvestment then you might see an OMO.

Q: Give us a sense of why the fear of no OMOs possibly led to that spike up that we saw yesterday?

A: If you see the policy rates are at 8.5% and by reading yesterday's policy there is a doubt now that in this fiscal there maybe any rate cut. So if you are postponing the rate cuts to April, you are actually funding your bonds even at 8.5% or maybe even higher.

Secondly, I would say that government has actually borrowed Rs 93,000 crore additional in this fiscal through bonds and over and above that the point which is missed out is they have increased the Treasury Bill supply by Rs 1,20,000 crore in this year. So it is in totality Rs 2,00,000 core extra which the government needed to borrow through T-Bills and Government dated Securities.

To balance that I think RBI has already done a large amount of OMOs; it helps in creating base money also. If you get into specific bond market dynamics, the net supply in the month of December and January was zero till now because of the OMO buybacks and the buying by the FIIs which more or les filled up the limits. So that adjustment is taking place because now there will be no consecutive OMO along with the bond auctions, so it is that kind of adjustment which has happened. But I would still say 10-year bond yields can hover between 8.25-8.50% for the whole quarter even without the OMOs.

Q: What would you advice a longer-term investor in bonds?

A: I am also in the same camp that there would be a reduction of 100 basis points in FY13, but the timing is unknown. It is very difficult because I think the RBI is going through a lot of issues at the moment; there has been the rupee depreciation which was troublesome and the bond yields had spiked to 9%, core inflation still at 7%, headline inflation numbers are expected to be between 6.5-7% for the next 2-3 months. So I think as the Deputy Governor mentioned yesterday, there are lot many goalposts which we need to pass through before we take a big call on rates going down.

Over and above that, we need to see the Budget numbers before we take a big call on rates, the long-end yields going down drastically or moving in what direction. So I think the 10-year bond yields should be hovering between 8.25-8.50% for this quarter and lot more things we need to see. We have to go through the advance tax liquidity shortage in the month of March, we need to see the budget numbers and finally we need to se what is the gross borrowing and then we take that call.

But on the repo rate cut, I would expect there is overall expectation that repo rate might get cut by 100 basis points in one year's time, so whether it is May-June or May -October is yet to be seen.