See new 10-year bond yield in 6.75-7.30% over 1 yr: Experts

The new 10-year bonds to be auctioned by the government on Friday are seen trading with a yield of 6.75-7.30 percent over next one year on hopes of lower inflation, experts said.

The government will auction a new benchmark note maturing in 2023 on May 17, RBI had informed the market by e-mail on May 13.
"The new 10-year which has been announced which is going to be issued on Friday is already trading below 7.25 percent (in the when-issued market) right now. So I would say the range for the new 10-year would be anywhere between 6.75-7.30 percent for the next one year," Sandeep Bagla, ICICI Securities said.
Government bonds continued their rally today on hopes of a rate cut after lower than expected inflation numbers. The yield on the 10 year bond which fell from 7.57 percent to 7.47 percent yesterday, fell further to 7.4 percent today.
The yield on the benchmark 10-year bond closed at an almost three-year low on Tuesday after inflation measured by the wholesale-price index (WPI) fell below 5 percent. Comments of central bank Governor Duvvuri Subbarao on Tuesday that the slowest inflation since 2009 will be factored into policy decisions also fueled investors hope for rate cut. Also read: 10-year yield seen between 7.40-7.50%: Ramanathan K
"The inflation trajectory for the next one year on an average is going to be lower than 5 percent. Historically we have seen the 10-year bond typically trade 150-200 bps over the average expected inflation. If you go by that, the range for the 10-year would be anywhere between 6.5-7.25 percent," Bagla said.
Jayesh Mehta, Bank of America also sees yield of new 10-year bonds trading at around 6.75-6.70 percent for next six months. Below is the verbatim transcript of the discussion on government and corporate bonds.  Q: What is the Overnight Index Swap (OIS) market telling you in terms of what are the expectations in terms of rate cuts now? Mehta: People are looking at multiple rate cuts. Overall data looks bad and people are actually now going to the extreme of looking at the next resistance level which could be as low as sub-6 percent, 6.40 percent kind of levels for 5-year OIS. Q: What is the OIS now trading in that case? Mehta: Right now it is in the range of 6.60-6.70 percent or so. We would look at next stop coming at maybe 6.40 percent or so, that is what people are expecting looking at technicals. More importantly, more than OIS it is on the bond side where the whole rally is about. People were actually much shy of the bonds particularly because of the supply. OIS was kind of always trading below the G-Sec, but now I think G-Sec is catching up with OIS. Q: 5-year OIS is at 6.60 percent at this point is indicating what, three rate cuts now? Mehta: Yes. People are looking at two to three rate cuts, maybe 50 bps CRR cut and OMO to continue. People are looking at overall macro data which is looking terrible at this juncture. As you know whatever we are going through on the macroeconomic side there are no new projects, no other things coming up in the market at this juncture and the credit therefore is not really that buoyant. Q: What you would be recommending to investors in terms of investment into the G-Sec now in the sense that do you see a further rally coming in from the current levels of around 7.38 percent? Bagla: We have had a very swift and brisk rally, but it is not really very surprising if you look at the inflation trajectory. The inflation trajectory for the next one year on an average is going to be lower than 5 percent. Historically we have seen the 10-year bond typically trade 150-200 bps over the average expected inflation. If you go by that, the range for the 10-year would be anywhere between 6.5-7.25 percent. The new 10-year which has been announced which is going to be issued on Friday is already trading below 7.25 percent right now. So I would say the range for the new 10-year would be anywhere between 6.75-7.30 percent for the next one year. Q: In the when-issued market the 10-year is trading below 7.25 percent? Bagla: Yes, it traded at 7.22 percent when I left the office. Q: What do you think will be the cut-off when the auction happens on Friday? Bagla: I think it will be 7.20-7.30 percent. At 7.30 percent it is a strong buy. Q: Do you think that for this quarter itself up until June 30th it could go towards 7 percent? What is the low expected on the 10-year up until June 30th? Bagla: It is very difficult to say, especially the short-term, but by June 30th we will have one more Wholesale Price Index (WPI) reading, one Consumer Price Index (CPI) reading, one GDP reading, so yes, there is a good chance that we will see 7.10 percent on the new 10-year by June 30th. Q: What is happening with the rupee in that case? The rupee seems to be back on the grind trading at a one-month low. What sort of range would you peg for the rupee and what are the next triggers that we can expect? Mehta: The general view on rupee is bullish. When we started the year or maybe last quarter we were looking at rupee to be completely falling, but then the gold and oil really changed the situation. We are looking at 53-55 range and I think it tried testing 55 last two-three days, but did not really break it. Maybe one of the reasons not appreciating so fast is also RBI building up their reserves. So we think that rupee will be well defended and we think the range will continue between 53-55 which is not really volatile range.
_PAGEBREAK_ Q: Do you agree that the new 10-year could trade in this quarter itself all the way down to 7.1 percent or do you have an even more optimistic view? What happens to the Certificate of Deposit (CD)/Commercial Paper (CP) market? Where are the yields now for 1-year? Where do you see those yields trending in this quarter? Mehta: In terms of CD/CP that is roughly around 8.9 percent or so, but there is no new fresh issuance of CDs happening, so that will keep on trending around that levels. If you look at long-term bonds, a 5-year corporate bond or a 10-year corporate bond is all at 7.95-8 percent. So that is definitely there. There is not much of a new supply coming in there. As far as bonds are concerned I agree with Sandeep thematically next six months we are looking at maybe the range of around maybe 6.75-6.70 percent, but immediately in next one month it is little difficult to say apart from all the data which is coming in. We also have Rs 60,000 crore of new supply coming in till the next policy. That will kind of get in the little bit of fatigue in the market. Unless the next policy is supported by OMO, (which we do expect it to support) then we are looking at 7.10 percent before the policy itself. Q: Just wanted to take that point forward with regards to liquidity because in the past couple of policies we heard bankers be quite vocal about the fact that transmission of rates is not going to be easy unless there is some amount of liquidity ease that comes in to the markets. At this point what exactly is the tightness in the liquidity situation and how do you expect it to pan out possibly in the coming few months. Do you expect it to ease at all or do you expect the RBI to just step in via open market operations (OMO) in order to ease the liquidity situation? Mehta: We expect RBI to come out with OMOs to ease the liquidity situation. Yesterday we were expecting but they skipped it. Maybe next Tuesday we should expect them coming back with OMO or I won’t be surprised if they do an interim cut before the policy which is very remote possibility but that might also happen because you have bond yields coming off so dramatically but the required base rate has not changed. Q: You mean banks could come out with a cut before the policy itself – is that what you are saying- state owned banks. Mehta: That looks little difficult. Looking at the bank stand, which most of the banks have been taking unless there is some policy action before that. Q: Jayesh was saying that corporate bonds are closer to 8 percent now. If the ten year were indeed to go all the way down to 6.75 and the growth picture remains as bleak. It is always bleak in the slack season up until the rains are over – do you think corporate bonds also could see a come off in yields? Bagla: Yes. I think corporate bonds yields will also come down. Right now what is happening is that, mutual funds and investors who are invested in Commercial Papers/certificate of deposit (CP/CD) are getting out of CP/CDs and selling them at 8-8.05 and getting into long duration G-Sec. Once that switch is over gradually corporate bonds, CP/CDs they will all soften. Yes, we expect corporate bond yields to come down also. Q: Long-term G-Sec has given an annualised return of around 14 percent in the past year – going forward what is the estimated return that we can see possibly if in case there is interest in long-term G-Sec from current levels? Bagla: If one looks at it that way, if there is a 50 bps further softening in bond yields, one will get about 3.5-4 percent capital gains, one will get 11-12 percent return on G-Sec, I would guess. Q: Therefore what would you advice investors, as an head of a fund what would you recommend- should people be buying into bond funds. What kind of fixed income funds? Which is a good return and even compared to equities do you think these funds can offer better returns -fixed income funds? Mehta: No. I think long-term bond fund definitely looks good, whether long-term bond fund, long-term G-Sec fund definitely looks good at this juncture. If one is looking at 50 bps lower we are looking at around 10 percent return. 10 percent return through a mutual fund. But again one has pros and cons of fund manager buying at the right time and selling so that one has to look at it and one has to choose that fund.
But definitely if one looks at standalone, yes 50 bps is what one is expecting but that may not happen overnight – it may actually have some technical corrections in between but maybe broader period of six months time one can look at that kind of a return. Q: The reason why I asked you about corporate bonds is because you were the one who was most bullish or at least one of the many who were bullish after the withholding tax was cut to 5 percent – we have not seen that money start to come – I guess it will take its time but that is a full 35 billion available – even if some part of that were to come should one expect a rally in the corporate bond market- outsize rally in corporate bond market? Mehta: That will come. On the withholding tax one of the things which we had said, we have till now short-term traders, definitely they have come in. We will see some more inflows in this month too. But the big real money will actually come at least two three months away because the regulation just came in. One needs some more details to be seen, people taking and setting up their internal process and maybe if it is a fund abroad it takes at least three months to launch a new fund scheme to invest in India. That is at least three-four months but the process is on. People are looking at it, people are preparing themselves internally to invest in India.