Where are bond yield headed? IDFC Mutual Fund answers

The market is absolutely tight with respect to cash and has no appetite for the tidal wave of government bonds that keep hitting the market and keep getting auctioned every Friday.

Suyash Choudhary, head of fixed income at IDFC Mutual Fund shared his perspective on how long the Rs 10,000-crore relief will last. He expects the total amount of infusion to be between Rs 60,000-70,000 crore. Moreover, he believes liquidity deficit to go towards Rs 1, 40,000 crore by March if RBI does not intervene.

Here is the edited transcript of his interview to CNBC-TV18. Also watch the accompanying video.

Q: The market is looking at 8.79% on the 10-year paper. Can the yields fall more? Can the good times last or will the low yields require another injection of open market operation (OMO)?

A: The Rs 10,000 crore is a big relief for the markets. If we look at the OMOs in context of the total liquidity that the RBI will have to create, we are using 1% net demand and time liabilities (NDTL) market as the guidance. So, they are not comfortable keeping liquidity deficit roughly beyond minus Rs 60,000 crore.

Given that calculation, we expect a total OMO size of between Rs 60,000-70,000 crore from here till January. The size will be similar to last year. The bigger point regarding OMOs right now is whether operationally they will succeed or not.

This time around, the difference between the first half average costing for banks and where the yields are today is quite high. Whether the market wants to surrender bonds at current levels or RBI would accept them 20-25 basis lower is the problem.

The other problem is with respect to the ongoing supply as well. By mid-December, there can be another review of the fiscal deficit target, which may throw a little more bond supply to the market as well.

It is unlikely that the highs tested last week on bond yields will get repeated, but at the same time, the quantum of fall will depend on the net demand versus supply and whether OMOs succeed in delivering that liquidity.

Q: How important is the choice of bonds at the auction? Previously, when the buyback had taken place, it was pretty badly hit due to the choice of illiquid and out of money bonds. How important would this be?

A: It is extremely important. If the average costing for the first half is around 8.40% or 8.30% on the 10-year, which is already off the run and we are sitting at close to 8.85% on that stock, we need to have a meetings round in between.

One way to do it was to anonymously buy via screen, which would have alleviated a bit of the problem on bond selections. The total amount of infusion will be between Rs 60,000-70,000 crore.

Q: The total amount of infusion between Rs 60,000-70,000 crore is a pretty tall number. We are also faced with a depreciating rupee. In that context, can the RBI go that far in terms of pushing money into the system? Won’t it have its own impact on depreciation?

A: We are going by RBI’s own assessment that they are comfortable with 1% of NDTL. One variable that impacts domestic liquidity is rise in currency with public. We have already seen first round of massive rise in currency with public around Diwali.

Between January to March, we will lose another Rs 30,000-40,000 crore on that account, which is a seasonal element that repeats every year. Liquidity deficit will go towards Rs 1, 40,000 crore by March if RBI does not intervene. The differential between Rs 1, 40,000-1, 60,000 needs to be injected.

If the RBI has to intervene in the rupee market, they will need to suck out the liquidity and release dollars.

Q: You expect the highly interventionist RBI buying in the bond market and supplying dollars in the Forex market?

A: Based on currency to a very large extent.

Q: What kind of a range would you give the 10-year from now to December 31?

A: That’s a tough one, but broadly, we would go with something close to 8.75-9%.