Where is bond market headed? Experts discuss

In an interview to CNBC-TV18, Dhawal Dalal, DSP BlackRock and A Prasanna, chief economist of I-Sec, speak about the bond market and give their outlook going forward.

Below is the edited transcript of the interview. Also watch the accompanying video. Q: Where are bond yields headed? Up until the next couple of weeks, do you think you are going to see more gains in bond prices because of the new 10-year? Dalal: Before the GDP data, most of the market participants were cautious in terms of their positioning. But after the sudden decline in the GDP, market participants are now beginning to factor in possibility of a rate cut by RBI. As a result of that, they have started increasing duration of their portfolio. Our sense is that if the RBI reduces the benchmark repo rate by 25 bps then you could probably see the 10-year yield trading between 8.10-8.25%. Q: What are you making with regards to the bond yields at this point in time and the strong rally that we have seen? What sort of liquidity deficit are the bonds working with right now? Prasanna: As far as where bond yields are right now, I think you have to understand that RBI has been committing OMOs and they have taken quite a bit of duration out of the market. Market was well positioned to capitalise on any positive news. I think over the last week we have had two positives for bonds. One is that the growth numbers came quite bad and second is global oil prices have also crashed by around 10%. So, both these factors are helping bond markets. In terms of growth variables, probably the news is not going to improve anytime soon. So, that positive factor is likely to continue. It looks like oil is rebounding a bit, but by and large if you compare with the situation one or two months back, the oil prices are much lower. So, that is another positive for the bonds. So, irrespective of whether RBI cuts rates or not, I think positive sentiment is likely to prevail in the bond market. Q: Even at 8.36% at this point in time, you would be a buyer? Prasanna: Yes, we would be buyers.  There is a new 10-year bond. So, probably the 8.36% is not reflective of where the actual pricing is. The new 10-year is likely to cut off lower than that, I would say somewhere between 8.20-8.25%. It should trade around those levels. Q: How did you read Subir Gokarn yesterday? What would you draw from that in terms of June 18 and thereafter? Prasanna: There was an inclination that probably RBI is a bit more open to lowering rates. I don’t know whether it is going to happen on June 18, but definitely whatever we discussed in terms of growth numbers as well as oil prices, as well as the fact that core inflation has been well behaved in India over the last three months, I think that seems to be giving some comfort to RBI. I wouldn’t jump to a conclusion that probably on June 18 itself we are seeing a cut. The conditions are in place for a cut by July. Q: What is currently the liquidity deficit that the markets are working with? Hence, what is the likelihood of a possible CRR cut going forward? Dalal: Current liquidity deficit is of around Rs 80,000 crore. Market participants could expect a CRR cut. But given the kind of decline in oil prices and the relative depreciation of the rupee against the major currency, which is actually going to help us reduce the current account deficit, I think the environment is conducive for the RBI to consider cutting rates. That will be bullish for the bonds in the medium to long-term. Q: If on June 18 you do get a cut, do you expect yields to go to 8%? Dalal: From a technical perspective, the first level to look at is around 8.25%. But as Prasanna pointed out that the new 10-year is already going to be at around 8.20% and it may trade even lower than that, then we can probably test the previous lows of around 8.10%. On the long-term, if the global environment remains conducive and oil continues to remain lower then we could probably see the 10-year even falling below 8% over the medium to long-term period. Q: What is medium to long term, up until September 30? What is your period? Dalal: I would probably say six months to nine months. Q: Where would you place the 10-year or any long-term yield up until September 30? Prasanna: Markets always tend to overshoot. More than markets, people opinion always tend to swing in extremes. I don’t think it is going to breach 8%. Probably, we will hit that 8.20% mark with the new 10-year and probably trade around that. That is based on may be we are not going to see a rate cut on June 18. Therefore, I don’t think bonds would rally too much. But the sentiment will continue to be positive and therefore we will kind of stabilise between 8.15% and 8.25%.