Bond yields may drift 25 bps down on another OMO: HSBC

Below is the verbatim transcript of Manish Wadhawan's interview on CNBC-TV18

Q: What is the money market factoring in right now as we head into next week’s monetary policy, what is the current indication and what is your own call?

A: Since the beginning of the year we have seen a lot of positive developments in the rates markets and money markets. First the inflation number came down and that was a positive surprise but beyond that I think there have been more positive surprises in the form of the government cancelling their auction and then the stance of Reserve Bank of India (RBI) in terms of liquidity. In fact, one of the important announcements, which happened yesterday was that RBI had announced another additional liquidity adjustment facility (LAF) for a 28 day period for an amount of Rs 20,000 crore, which primarily puts the overnight rates between the marginal standing facility (MSF) and the repo rate.

So that I think was a very important announcement yesterday, which has been positive for markets. In addition to that there has been an open market operations (OMO) announcement also for bond buyback by RBI. So putting all the things together, there have been positive announcement happening since the beginning of the year and we have seen it getting manifested in yields, which have come down something like 32-35 bps from the beginning of the year on the 10-year bond.

Q: Taking that point forward on the OMO as well as the LAF announcement yesterday. Do you think that the yields have adjusted to both of those announcements or do you see further softness coming in on the yields or just on the basis of these two things?

A: I appreciate where you are coming from that we have already seen a large rally which has happened in the markets and one by one, there have been positive news in the markets. But because we are coming out of 2013, which was a year of tightening and the policy stance was very hawkish by RBI, I would accept that a large move has happened but the positive bias will still continue because inflation has surprised on the positive side. People would definitely wait out for the monetary policy announcement on 28th to make a further call on that but putting everything together it seems that the stance of RBI has changed a bit first in terms of liquidity. They are looking to inject some kind of permanent liquidity into system because OMO is a manifestation of that.

Over and above that they are already increasing the amount available through repos to the banking system beyond the 1 percent limit, which they have put forward to. So all these things put together if inflation is showing some trajectory, which is positive you might see further softening of yields because as of now markets are still worried about that overnight rate at 8.75, which is MSF or it is at 7.75 which is repo. If there is some kind of clarity or confirmation from RBI that they are looking at overnight rates or repo, the yields can soften a bit more.

Q: Since the start of the year we have seen quite a bit of inflow from foreign institutional investors (FIIs) into debt. What would explain that and would you expect that to continue? We have seen in the US also, yields have slipped from 3 to 2.8 mark or so and that has led to quite a bit of risk-on as well?

A: In fact it is a very important point that you are raising here. The positioning from the FIIs in the debt segment in India has been quite light for the last six months. They have been sellers from July to November onwards, they started buying something in November, December. We have seen quite a lot of positive inflows into the country from some large sovereign funds also and large FIIs into the market. Over and above that, I would say with a pinch of salt because the forwards have collapsed the offshore, it leads to a lot of buying interest rebuilds at the short end of the segment which also gets counted as FII debt buying which I would say is more of arbitrage money.

So you know one should not celebrate, it is too early on account of FII debt flows but we are seeing positive bias from the FIIs into the Indian markets. We have seen queries in terms of long end and you are seeing buying happening. So I would say it is a mix of both. So at the short end, at the long end, the trend seems to be that they are looking to buy only in the debt segment and they are drawing comfort from the rupee stabilising and I think in 2014, rupee has been one of the most stable currencies across Asia, which is helping this flow.

Q: What is the yield factoring in going into next Tuesday’s RBI meet?

A: I think the yields are factoring in that RBI is holding on to the repo rate at 7.75, no change but the more important thing would be how do they give the message on liquidity because in his first policy governor Rajan had mentioned that he would like overnight rates to be at repo rate subject to the unwinding of the Fx swaps done with the oil companies. All of those factors which he had raised or concerns are already out of the way and we have seen those kind of things.

Rupee has stabilised quite a lot, we believe that the outstanding swaps with oil companies, they have already covered majority of the portion of that and would start seeing them unwinding with RBI from February or March onwards. All the things are falling into place at the moment. I would expect that RBI would stay put on repo rate there but you might get some positive surprise on liquidity. Beyond that we need to hear the governor to take further calls from here.

Q: What are your targets on the yields ahead of the RBI policy as well as if in case there is a disappointment on the RBI policy, where do you expect yields to maybe harden to or maybe will it be compensated by the current softness in the liquidity situation that we are seeing?

A: We have already moved around 35 bps lower in the 10-year in this year itself from somewhere around 8.85 to 8.50 percent levels where we are today. But it is not only the stance of RBI or liquidity, it is the confluence of a lot of factors which are happening.

Q: But would you have any target, your near term target for the yield?

A: If in the current circumstances RBI announces another OMO, you could see yields drifting down by at least 25 bps or more because at the moment, the way things are placed, this quarter there is no supply at all and the demand from the insurance sector and on account of liquidity, if the demand increases for government bonds, we are not seeing the same amount of increase in credit growth as we are seeing in the deposit growth. So government adding liquidity, RBI adding liquidity and if RBI announces further OMO, you could see yields drifting at least 15-20 bps lower.