Bonds to rally further on rate cut expectations: StanChart

Agam Gupta of Standard Chartered Bank believes that the rally in bond market is due to a combination of factors. 1) No bond auction this week and 2) inflation and trade gap coming lower-than-expected, coupled with commodity prices continuing to remain low. "It has led to the consensus view that a rate cut is imminent in the upcoming monetary policy," Gupta told CNBC-TV18 in an interview. 

Commenting on the dollar rupee, he says, people are turning cautiously bullish on Indian rupee because all the above mentioned factors will have positive impact on trade deficit, current account deficit (CAD) and the fiscal deficit. However, he believes that if the RBI cuts rates and sounds hawkish it will definitely disappoint the market. He expects bonds to rally another 3-5 basis points up until the monetary policy. Below is the verbatim transcript of his interview on CNBC-TV18 Q: There is a decent bit of rally in bonds that we have seen from the 7.85 levels that we traded two weeks ago. To what do we owe this? Is it just temporary because there is no bond auction this week? A: It is because of a combination of factors. One is that now there is no bond auction in the run up to the monetary policy. Secondly, the main reason is that because of the inflation trend coming lower than expected, the trade gap coming lower than expected and the kind of continuation of commodity prices remaining low, combination of all these factors lead us to believe that a rate cut is imminent in the monetary policy. That is pretty much the consensus view right now so that is what is causing the bond market rally right now. Q: Do you expect the rally to continue?  Till May 03, where do you expect the bond prices to be? Has it more or less factored in a 25 bps rate cut and if it does come through, is it not going to surprise the bond markets? A: The consensus view is that there will be a rate cut in the monetary policy. Having said that we can still rally another 4-5 basis points from here into the monetary policy. We can go to 7.7 percent in the coming days before stopping, and before going in for a pause in the rally into the monetary policy. So another 3-5 bps rally possible into the monetary policy. Q: It is only a rate cut that is expected? Is the market expecting anything more? A: The fact is that liquidity deficit in the system has increased and the core liquidity deficit is close to Rs 60,000 crore, right now, It is on the slightly higher side of the RBI comfort level. So, there is an expectation that the Reserve Bank of India (RBI) will probably have to do something to ease liquidity as well going forward. However, the question is whether it will be announced in the monetary policy or outside the policy. It could be in the form of Open Market Operations (OMO) bond purchases, part of it could be through buying spot dollars in the foreign exchange market and if the RBI thinks that these are not sufficient then they might also tinker around with the cash reserve ratio (CRR) in the monetary policy. Q: RBI has always been a little hawkish, so if they give the cut but remind you that consumer price index (CPI) is still ugly, how will the market react? A: If they cut rates and sound hawkish then that will definitely disappoint the market. What they have to recognise is that inflation prints are coming lower than expected, growth is lower than expected, commodity prices are lower than expected, and the global slowdown is probably going to be more severe than thought earlier and the current account deficit (CAD) or the trade data is looking better than it was previously thought so. Keeping all this in mind if they cut rates and sound a hawkish then the market will definitely be disappointed. Q: Has the street increased its expectations of the quantum of rate cut through FY14 after the fall in commodity prices? A: Yes, definitely anecdotal evidence does suggest that people, who were calling for 25-50 bps of cut through the financial year, are now calling for 50-70 bps. So the lowering of inflation, trade data deficit and commodity prices are definitely leading to an expectation of more rate cuts then you would have though may be three months ago. _PAGEBREAK_ Q: Is it reflecting in the overnight index swap (OIS)? A: Yes it is showing in the OIS market, the one year OIS is definitely discounting 75 bps of rate cuts. Q: What is your range for the quarter with the assumptions that you have spoken about in the credit policy, what would be your assumptions for the year? Are we going to see a 10 year at 7 percent? A: That is far away and you have to keep in mind that the government borrowing program has also just started and will take off in right earnest after the monetary policy. May is a heavy month of supply and we have five auctions in May and more or less you have auction every month after the monetary policy. So you have to keep in mind that the repo rate might be cut 25-50 bps but the curve can become steep if the supply keeps hitting the market. One will also have to keep an eye on how commodity prices are behaving, how the inflation trajectory is going to pan out and how the current account data, trade data comes. The basic point is that there are more expectations of rate cuts than previously but you have to keep in mind these factors also. Q: What explains the record volumes that we have seen in Thursday’s session in the bond market, even today? Do you expect these kind of volumes to continue? A: When the market is bullish volumes are always high and with the fact that there has been increased Foreign Institutional Investor (FII) participation in the market, in the last three-six months, the volumes will remain high till the market remains bullish. Currently the volumes are getting driven by the fact that there is an expectation of a rate cut in the policy and also due to all the positives that are playing out one after the other. Q: What is your hunch on currencies; on euro-dollar with little bit of risk on we saw on Friday we didn’t quite take 1.31 on euro, we are still sub 1.31?  On the dollar-rupee, will dollar strength prevail because of the global strength of the dollar or will we continue to be an outlier and be a relative outperformer? What is the dollar-rupee telling you for up until June? A: The sentiment has definitely turned on the Indian rupee (INR). If you had talked to people three months ago most of the people were slightly bearish on the INR because of all the factors that we listed out like decreasing inflation, trade deficit lower than expected, oil prices, commodity prices in a downtrend. All this is going to have a positive impact on the trade deficit and the CAD and the fiscal deficit. So people are definitely turning cautiously bullish on the INR. It is reflecting in the market, we have seen a lot of selling of dollars in the last week. We are right now caught in a lower range of 53.5-54.5. What we have seen is increased demand from nationalized banks for dollars in the last week. We suspect it could be on behalf of the RBI and anecdotal evidence does suggest that because their demand has definitely picked up. If that increased demand would not have been there we would have been at 53 by now and now at 54. So we are in a range of 53.5-54.5 for the very short-term right now with nationalized bank demand capping the downside.