Bond yields to hover around 7.4% till August: Bank of America

The focal-point in today's bi-monthly RBI policy is inflation expectations could surprise on the upside and its monetary stance in response.The Reserve Bank of India left the repo rate untouched, however, expressed concerns over a rise in inflation, particularly in food and services spaces.But both stock and bond markets took the decision in their stride, as a no-cut stance was expected and priced in.Tirthankar Patnaik, India Strategist at Mizuho Bank, believes that the RBI's prime focus right now is on the many macro events that will unfold in the due course of time, and the central bank's stance on tackling them will gradually shape out the need to cut repo rate later this year.He added that the market would look forward to transmission of policy, the impact of foreign currency non-resident (FCNR) outflows and whether Rajan gets a second term.Jayesh Mehta, MD & Country Treasurer, Bank of America said that he expects one more rate cut in August and but nothing dramatic on the MCLR front.Mehta also said that the money market is unlikely to get to liquidity-neutral state despite the RBI's push and that bond yields will hover around current levels, plus or minus 5-7 bps at least till August.Below is the verbatim transcript of Tirthankar Patnaik and Jayesh Mehta's interview on CNBC-TV18.Latha: The markets have reacted and are done with. Has the market yet to digest the fact that there may not be any more rate cuts. Will that be a new shock? For you as a stock market advisor what does this policy mean and what does the monetary policy itself mean? Patnaik: The expectations were that of a pause this time and the markets weren't really expecting too much from this particular policy. There are - as has been pointed out earlier - enough and more macro events coming up in the next few months which will take up the RBI's focus much more in terms of how to deal with them before taking an incremental stake on the repo rate. Clearly, monetary transmission is important. The RBI is looking at assessing the MCLR mechanism again just to see if there is something that can be done more in terms of banks actually passing on some of the benefits. We have seen about 70-75 bps cut on the lending rates even as the RBI has done its bit in terms of 150 bps cut. To my mind, the policy's focus on a sharp rise in inflation also reduces the potential for accommodative stance. Even though the governor was clear both in the policy and in the press conference afterwards that they continue to look forward to cutting rates further as conditions materialise. The other important part the market would be looking forward to would be how this entire event of the FCNR episode actually pans out in September. Notice that is also about the time when we might have some uncertainty. Hopefully not, of the governor actually receiving a second term as the RBI governor going forward. So, those are the events that the markets would be looking forward to. In terms of rates we are at a pause for now. Latha: RBI on hold, they are still accommodative, but there is an upward bias to the inflation. Would you still expect a rate cut? How would you look at bond yields? Mehta: I am still a big follower of liquidity. I would still look at July getting surplus. If that surplus is there, the impact would be more than the rate cut. But anyway, this inflation number, April-May was supposed to be higher. We may have a different situation, but we still expect one more rate cut maybe in August.Latha: What are your key takeaways? Are you getting a sense that the money markets are going to find more liquidity? How do you see the 7.4 barrier getting broken on the ten year yield? Mehta: I do not think we would be in a hurry to get liquidity looking at the post policy situation. So, maybe yes, the flows which will come in July-August, but I do not know how long that will sustain that positive liquidity or neutral liquidity. So, that is a little bit of a concern. Of course the markets are back to normal looking at global cues, we will have the Fed, the Brexit, again Fed in July and of course, September maturity. So from that perspective, we will not see anything happening dramatically on either side, maybe plus, minus 5-7 basis points on either side at this juncture at least till August. Let us see how it progresses in August. But more importantly, it is a little disappointing on the liquidity side because as we say, the lending rate, as the governor said, as deposit increase people will start reducing rates, but if you look at May, 2013 data, the deposits have grown up, but people have just reduced the repo borrowing. So, still it becomes neutral to expect anything dramatic on the MCLR or any reduction on the rate is a little difficult.