Expect 7.15-7.18% on new 10-year bond yield: Nomura

In an interview to CNBC-TV18, Vivek Rajpal of Nomura India said that he expects the Reserve Bank of India (RBI) to reduce rates in its July credit policy as the fall in WPI inflation has increased the probability of a rate cut.

Meanwhile, he expects the new 10-year benchmark bond yields to hover in 7.15-7.18 percent range. One should be adopt a strategic approach while playing the market now. "Don't be in a hurry to take profits because the market is aligning to a new terminal rate, to a new inflationary trajectory, bond yields are falling, so one should take long bond positions and play out the rally," he recommended. Also read: RBI can buy $9 bn more forex from market: BofA-ML Below is the verbatim transcript of his interview on CNBC-TV18 Q: You wrote a report that the big question for India rate strategy now is the problem of plenty and not how much the yield should come down but what you should be picking. What is your overall call? Are we going to see 7 percent in next one-two quarters on the benchmark yield? A: Seven percent on ten year bond yield is highly possible and probably much sooner than one-two quarters. I think one of the key reasons of this rally is that market is aligning itself to a lower repo rate in the future. Fifteen-twenty days or a month back we were talking about 7-7.25 percent as the repo rate. However, some of the data points such as fall in consumer price index (CPI) inflation, a significant fall in wholesale price index (WPI) inflation, has opened the possibility of a new low in the rep o rate. So, the market is aligning itself to a new terminal repo rate (I don’t know if terminal is the right word). Market is definitely open to 6.50 or 6.75 percent as repo rate because of changed fundamentals, especially inflation. Q: I want more details on the new issuance, which is going to be auctioned today. What sorts of yields and demands are expected on that? A: I think 15-20 basis points premium versus the older benchmark can easily be thought about. 7.33 percent is a level on the older 10-year benchmark, which effectively means that we can see 7.15-7.18 percent kind of levels on new 10-year benchmark. This is where the market will try to price it. Q: Talking about what the Reserve Bank of India (RBI) is doing because there is some bit of debate on what happened post WPI numbers - which led to a big rally in the market to begin with. Some say that a rate cut in both June and July should happen but there is also a view that maybe in June there won’t be anything and the next rate cut will only happen in July. What is your house call? A: Our house call is a rate cut in the month of July. We are still not assigning June rate cut as a base case. However, having said that the fall in WPI inflation has definitely increased the probability of a rate cut. At the moment it is not about whether we will get the rate cut or not, it is just about timing of the rate cut. So, if RBI Governor sticks to no rate cut in the June policy meeting, he will definitely sound dovish and he will definitely signal more rate cut. Therefore, it is no more a matter of whether we will get rate cuts or not, it is just a matter of timing. So, even if we do not get a rate cut in June policy, we will definitely see dovish statements and acknowledgement of the fact that WPI inflation has come within their comfort zone. _PAGEBREAK_ Q: Overall as a strategy what are you recommending to institutional clients now on the Gilts? A: We are recommending clients to be strategic in their approach and not be in too much hurry to take profits. Market is aligning itself to a new terminal rate, to a new inflation trajectory, bond yields are falling and so and one should not try to be too tactical in this market. One should take long bond position and one should play out the rally. The maximum one can be tactical about is choosing which part of the curve one can go long on. For example if one is running shorter duration, one can look to extent duration or if one is running corporate bonds then one can tactically look to switch to sovereign bonds. That is the kind of approach one can take to generate alpha. However, one should not question the fall in yields, which is going down. Q: The key question with regards to the situation is the liquidity deficit that we are still suffering from. Transmission of rates has been tough till now for banks because of the tightness in the liquidity situation. Hence in your mind what is the likelihood of a possible cash reserve ratio (CRR) cut to come through in the June to July policy? Do you think RBI will be able to manage the liquidity situation via the open market operations (OMO) route, if in case they do not opt for a CRR? A: I think they will do both; open market operations as well as CRR; there are no two ways about it. The only reason why RBI is not so gung-ho or not so proactive to the standards of market requirement is because there are some things which are not in RBI’s control. For example, if RBI delivers just 25 bps CRR cut and if RBI does only four-five more OMOs in the current quarter, we may end up into a very benign liquidity situation by the month of September. The overall point remains that RBI is well aware of where the liquidity is. It knows that liquidity will improve going into the month of August and September. There are certain technical factors; one of the factors is currency with the public leakage - what happens in the month of July and August is that currency with the public comes back into the banking system, which in itself improves the liquidity. So even if RBI does 25 bps CRR cut and just conducts four-five more OMOs, liquidity conditions will be benign by the month of September and RBI knows it and therefore is going slow versus the market’s expectation.