Evening Wrap - Currency & Bond Markets

The Reserve Bank of India’s (RBI) monetary policy committee on December 8 maintained the status quo on key rates - repo rate remained unchanged at 4%, reverse repo rate at 3.35%, and MSF at 4.25%. The committee decided to maintain an ‘accommodative’ stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of COVID-19 on the economy while ensuring that inflation remains within the target going forward.

RBI highlighted that the downside risks remain significant rendering the outlook highly uncertain, especially on account of global spillovers, the potential resurgence in COVID-19 infections with new mutations, persisting shortages and bottlenecks, and the widening divergences in policy actions and stances across the world as inflationary pressures persist. A tightening of global financial conditions poses risks to global economic activity and to India’s prospects as well.

Bond Markets Today

RBI mentioned that the amount parked in overnight reverse repo has seen a reduction with the major portion of banking liquidity being parked in longer tenor VRRRs (variable-rate reverse repo) offering higher rates (~3.98%), making it the effective policy rate.

“The shorter end of the yield curve could flatten in the near term with further normalisation in the banking system liquidity. Recently, the yields at the shorter end have firmed up by 30-35 bps”, said Dhaval Kapadia, Director – Managed Portfolios, Morningstar Investment Adviser India. The 10-year benchmark G-sec is hovering in a tight range of 6.3% - 6.4% and may continue to be in this range amid a lack of fresh triggers, Kapadia added.

Indian 10-year bond yields came off by 4bps at 6.34 as the market participants cheered RBI’s dovish stance and were relieved that it did not follow the Fed’s hawkish view. “RBI is looking to normalise the short-term rates by absorption through VRR. As a result, it may flatten the yield curve going forward with short-term rates moving towards repo and long-term rates remaining capped thanks to dovish RBI, improving receipts of government, and lower oil prices”, said Anindya Banerjee, DVP, Currency Derivatives & Interest Rate Derivatives at Kotak Securities Ltd. We expect a range of 6.25-6.40 over the near term, Kapadia said further.

Deepak Jasani, Head of Retail Research, HDFC Securities expects that the RBI’s announcement about liquidity absorption through the auction route from January 2022, will put further upward pressure on the short end of the curve.

“Investors will struggle to post significant gains in bonds as we are around the turning point of the current low-interest-rate cycle”, Kapadia said. The annual return expectation from bonds would be more normalised as compared to high teen returns delivered in the last couple of years.

From a long-term perspective, bonds remain a necessary stabiliser for multi-asset portfolios, and medium-long duration bonds are likely to provide a cushion when equities sell-off as they offer attractive real rates.

Currency Markets Today

The USD/INR spot closed flat near 75.45 levels as RBI policy had little impact on USD/INR. “A bit of wobble was noticed post-policy as traders went long on policy divergence between dovish RBI and hawkish Fed, but thanks to lumpy corporate dollar flows, it returned to unchanged by the close”, said Banerjee from Kotak Securities Ltd.

Over the near term, the focus will shift to global markets, and there the risk-on mood in equity markets and strength in Chinese currency may rub against the strength in the US Dollar Index, added Banerjee. This could result in a range-bound market over the near term. “We expect a range of 75.20 and 75.65 over the near term”, he said.

The focus now is on this Friday’s US CPI data. A better than expected CPI print should increase further bets for the hawkish Fed and send the US Dollar higher once again. “The USD/INR spot has been trading above 75 zone all throughout this week and today’s dovish than expected RBI policy kept the uptrend in USDINR spot intact”, said Emkay Global Financial Services.

Also, the divergence between Fed and RBI policies will keep the USD/INR spot afloat. “But this week we expect 75.70 to act as a strong resistance, as a slew of IPO-related flows can keep a check on the upside in spot, with 75 acting as strong support. Only a break of 75.70 will push prices towards 76 zone”, the brokerage added.