25 bps rate cut won't push bonds further: HDFC Bank

The rally in government’s 10-year bond continues from its 26 month high levels on the hope of a rate cut by the Reserve Bank of India (RBI) at the end of this month. But Ajay Marwaha of HDFC Bank told CNBC-TV18 the bond market has factored in a 25 bps rate cut now. He believes a 25 bps cut, as expected by the street, to be a reality on January 29.

“Depending on the inflation number that we see next week, RBI is likely to cut 25 bps.
Further Marwaha says inflation may come in at 7.25 percent -7.30 percent and settle around 7 percent by March. Below is an edited transcript of Ajay Marwaha's interview on CNBC-TV18 Q: What exactly is the 10-year factoring in after 11th consecutive day of a rally and sitting at 26 month highs and if there is a disappointment vis-à-vis, what is currently being factored in and what levels do you expect the 10-year to go to?
A: The 10-year is where it is on account of a variety of reasons. It all started with the markets expectation of extra borrowing being put to rest a couple of weeks ago by the ministry and that was quite a positive signal. To add to that we had the postponement of the auction last week and this put together you also had the Rs 8000 crore Open Market Operations (OMOs) that took place.
So you had the market resting at peace that there would be no extra supply. At the same time there was deferment of existing supply and then you had the OMOs mopping up Rs 6000 crore. You had a situation where the markets caught a little short which has resulted in this kind of staggering rally. We have seen the 10-year yield now trade slightly below 7.90 percent this morning. We do expect that this should temper out a little.
There is expectation that there could be, depending on the inflation number that we see next week, the RBI's potential 25 bps rate cut. There is a segment of the market that believes that that rate cut could be slightly higher. But the market is balanced in terms of 25 bps view at this point. You would expect this as a little bit of exuberance and would see this kind of evening out next week once the auction supply actually hits the market.

Q: Are you saying that at current levels it is factoring in 25 bps?
A: I would say so. After the event depending on the kind of rhetoric that we see in the policy, you could see the markets stabilising here and then deciding when the next rate cut is and attempting to factor parts of it; so that’s a possibility. But to see a large rally from these levels on a 25 bps rate cut is unlikely.
The interesting thing in the last two weeks which tells you that the market is factoring in that 25 bps is not what has happened to bonds but to the treasury bill cut offs and the secondary market trading on treasury bills. For example, one year bill has now traded substantially below 8 percent, it is trading close to 7.85 percent and even the six months treasury bill is now trading sub 8 percent. These yields are about 20 bps lower roughly over the course of the last four weeks. So that is a more appropriate picture of what the market has started discounting.
_PAGEBREAK_

Q: How will the inflation number look like? Is it expected to be higher than the 7.25 percent that we reported for November? What might be the market reaction if it is a tad higher? What is your forecast in the first place?
A: The inflation number will be in line with the expectations. So we expect a number of around 7.25 to 7.30 percent. We see the inflation number pan out closer to 7 percent by March. The important thing to look at is what happens to core inflation. Core inflation positively surprised us last time with 4.5 percent.
If that number is substantially below 5 percent again, the market will continue not only to factor in the existing 25 bps expectation for January but it may start factoring in an additional 25 bps either in March or even earlier. If that does happen, then you have a situation where bond yields could not only sustain this marginally but may even rally after a little bit of a breather post the policy.

Q: Are you selling at 7.89 percent?
A: Not yet.

Q: Do you expect it to go to 7.85 percent? What kind of lows are you expecting for the bond yields?
A: You are likely to have a situation where the trend is positive for bonds. So even if there is a 25 bps rate cut the market would continue to expect inflation to temper off to some extent over the course of the next few months. Q: There is a worry that the current account deficit might prevail on the RBIs thinking. So if for some reason, the RBI says that they are giving a 25 bps but there isn’t much room for monetary of fiscal stimulus at current levels, how would you read it and how do you think the markets will read it?
A: If you see a direction like that from the RBI where there is a possibility of a prolonged pause post a 25 bps rate cut, you would see the market taking a breather. You could see a correction back to 8-8.05 percent but even that is not going to sustain because overall the expectation is that in this calendar year itself you would see 50-75 bps worth of rate cuts at least.

Q: What about the rupee, do you manage to look at the rupee because that is being, the balance of payment (BOP) rather it is being supported by the capital inflows at this point in time? We haven’t seen any diverse or huge depreciation in the rupee. How is 2013 going to pan out for it in terms of a worst case scenario if in case the capital inflows do not continue on the robust trend that they did in 2012?
A: The rupee is suffering from the structural current account deficit situation that we have. The trade deficit is staggering. Over the last couple of months unfortunately, it is a slowdown in some of the invisibles, slowdown in remittances, a slight slowdown in nonresident flows which has led to pressure on the currency despite a USD 5 billion inflow in December on account of capital flows.
 
We do expect those flows to correct if the capital flows slowdown this kind of current account is not sustainable and you would see the rupee under pressure. Rupee will remain in the range of 54-56, it could trade under a little bit of pressure over the next couple of weeks or so. You should see it normalise and should also see some measures to curb gold imports as a lot of rhetoric going around.