Yields in upper band to benefit carry trades

Jackson Hole symposium speeches, Hurricane Harvey and Trump tax plans were the key topics that investors and traders carried home after a quiet last week. Indian markets yet again had a truncated working period with a Friday holiday.

Historically, several historic monetary policy decisions have been unfolded at the annual gathering of central bankers hosted by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming. But this year looks to be less momentous, with Federal Reserve chairperson Janet Yellen articulating on financial stability and avoiding monetary policy matters and ECB president Mario Draghi refraining from any reference to the winding down of the asset purchase programme. Global equities and bonds remained largely flat amid subdued volatility and towards Friday close, equities rose and dollar fell against majors after Yellen cited the likelihood of “the all-too-familiar risks of excessive optimism, leverage and maturity transformation re-emerging in new ways that require policy responses”, without making any hard references to the monetary stance. Analysts interpreted this as a likely Fed hike only in December. Additionally, market would draw comfort and strength from the statements that “the financial system is safer now than it was in the years surrounding the housing crisis and the global recovery is “firming up”.

Indian markets remained largely flat to negative with both bond yields and equities testing recent lows. Indian benchmark 10-year yield tested 6.55% while equities made fresh monthly lows before recovering towards the end of week. In the absence of fresh factors and the important inflation release behind trader focus, the debate will be how the remainder of the fiscal will pan out in terms of Government borrowing programme, fiscal deficit and government spending. The shortfall in RBI’s dividend payout to government, around Rs 35,000 crore (combined dividend shortfall from PSU payouts), will likely need to be addressed either in eschewing a marginal breach of fiscal targets or by curtailing fresh spending. Government spending has so far been front-loaded and has been a key driver in the investment space. Going forward, this could slacken.

The other key factor for markets will be the trajectory of retail inflation which is expected to remain well anchored within the Monetary Policy Committee’s range. The recent numbers perhaps overshot market estimates by 20-25 basis points but one of the biggest challenges for the economists and analysts has been an error-free inflation forecasting. While vegetables and food prices may remain elevated and the comfort of lower crude prices not being visible in domestic crude basket pricing (note the sharp increase in retail fuel prices from July), the risk of sharp spike in overall headline inflation remains low. Bond markets will keenly watch if there is a leeway for another rate cut this FY for further investment strategies and inflation-watch top the list of observables

In markets. the weekly bond auction was well bid with a bid to cover of 3.86 times and cut-offs coming in the expected range. System-level liquidity fell during the week on account of bunched up holidays and the need to maintain CRR products. This could also provide some support to bond prices as the likelihood of another OMO Sale looks less probable.

10-year benchmark has tested 6.55 and should attract buyers hereabouts. Within 6.40-6.60 range, we are close to the upper band and carry trades should benefit.

The writer is executive director, Lakshmi Vilas Bank

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