See 10-year yield heading to 8.6-8.7% by year-end: BoA

Reserve Bank of India’s (RBI) move to infuse more liquidity aims to keep the short-term liquidity easy and develop term money rates, says Jayesh Mehta, Managing Director & Country Treasurer, Bank of America. The central bank will infuse an additional Rs 10,000 crore into the system on Friday to ease the tight liquidity situation, ahead of commencement of advance tax payments in mid December.

Meanwhile, the bond market is prepared for a 0.25 percent rate hike on December 18, he said. However, whether RBI hikes rate or not, bonds will come off from the current levels.

"In both the scenarios there is going to be a lot of buying. If there is no hike then there can be huge rally. We might see bond yields much lower than where it is today on December 31 irrespective of whether there is any hike or not," he told CNBC-TV18 in an interview. He sees the 10-year yield heading to 8.6-8.7 percent by year-end.

After the RBI meet, all eyes will be glued to the FOMC meeting which will decide the fate of QE taper. Speaking about its impact on the Indian currency, Mehta said that irrespective of Fed’s decision on its monetary stimulus plan, the rupee won’t go to 63/USD and beyond.

Also Read: See Nov CPI at 10.78%; RBI may hike repo by 25 bps, say Experts

Below is the edited transcript of Jayesh Mehta’s interview with CNBC-TV18

Q: What did you make of the Reserve Bank of India’s (RBI) move yesterday to infuse more liquidity Rs 10,000 crore via the 14 day term repo tomorrow, how significant is it?

A: It is quite significant. There was a worry that we might move to marginal standing facility (MSF) rate again because of advance tax, with this Rs 10,000 crore, we would be at the repo rate overnight money market. It is a different story that market is expecting a 0.25 percent hike on December 18. So, the rate would move to 8 percent instead of 7.75, but it is still better than moving to 8.75 percent. It is definitely keeping the short-term liquidity easy while tightening the rate and that should be taken pretty well with the market.

Q: How much do you envisage in terms of tightening within the liquidity market once the advance tax payments begin mid-December? Do you think that the RBI will make such ad-hoc measures in order to keep liquidity comfortable besides the one that was announced last night?

A: It seems very clear that it wants overnight rates to be at the repo rate. There is also an agenda to develop the term money rates, so that extra 10,000 has been given not just for the repo, but to term money, but that is a different point altogether. But whether it is term money or repo at least it looks like that they will not keep overnight rate closer to repo rather than MSF, which is at 1 percent higher. That is good news.

The market is completely prepared at least for 0.25 percent hike. The bond market is almost pricing like more than 0.25 percent hike on the December 18. That is something market is spooked up about, but on the liquidity side, short-end is well supported.

Q: The market is completely expecting 25 bps hike, so if we get that, we are not going to be seeing any reaction in the bond market and just to follow up, hypothetically, if we do not get that, what is the bond market reaction that you expect then next week?

A: In both the scenarios there is going to be a lot of buying. Bonds will come off from the current level. Right now, there are two things happening. A lot of traders are out and nobody wants to take extra risk. Also, people are watching the tapering issue.

If there is no hike there can be huge rally, but even if with a 0.25 percent hike, market is expecting that this should be the last hike for chasing inflation. From that perspective, in both the scenarios, there will be considerable amount of buying. Our view is we might see bond yields much lower than what it is today on December 31 irrespective of whether there is hike or no hike.