Pre policy divergent trends, convergent post policy

By: Arjun Parthasarathy (arjunparthasarathy.com)

Bond yields are at calendar year highs, while equity indices and the currency are just off from calendar year highs, going into the RBI annual policy for 2011-12 scheduled for the 3rd of May 2011. The Ten year benchmark government bond the 7.80% 2021 bond is trading at 8.07% levels which is close to the highs of 8.11% seen for the benchmark bond this calendar year. The Sensex and the Nifty are trading at 19,400 and 5800 levels respectively which are a few percentage points off highs of 20,000 and 6150 seen in this calendar year.

The Rupee at Rs 44.50 to the USD is off 1% from highs of Rs 44.07 seen in this calendar year. The market trends going into the policy indicate that bonds are expecting the worst from the policy while equity and currency markets are more or less following their own trends and are quite indifferent to the outcome of the policy.

Post policy, all the markets, bond, equity and currency are all likely to show positive trends, despite RBI raising policy rates. The RBI is widely expected to raise the benchmark repo and reverse repo rate by 25bps to 50bps in their policy meet as they are committed to quelling fast rising inflation expectations. Inflation as measured by the WPI (Wholesale Price Index) came in at 8.98% for the month of March 2011, almost a percentage point higher than the RBI forecast of 8%. Rising oil prices ( crude oil is trading at multiyear highs with Brent crude at USD 123/bbl and Nymex crude at USD 112/bbl as of 26th April 2011) are further placing pressure on rising inflation trends.

Bond yields will fall post policy on the back of expectations that the RBI will temper their monetary policy stance going forward. The RBI over the last one year has raised the repo rate by 175bps and the reverse repo rate by 225 bps. A 25bps or a 50bps hike in the policy rates will take the repo and reverse repo rates to 7% or 7.25% and 6% or 6.25% respectively. The market will see these policy rates at close to the end of the RBI tightening regime as the RBI will more likely forecast inflation falling this year from last year