Let's briefly touch upon each point and how it affected debt markets - Inflation
CPI inflation touched a high of 5.40 % for the month of June 2015, even after accounting for favourable base effects. Price increase was seen in protein items like milk, meat and pulses. Prices of pulses have shown an increase of 30 to 40 % in the last one year.
One of the most worrying factors for the debt market was the increase in core inflation which excludes volatile items like food and fuel from the consideration set. Core inflation touched a high of 5%, for the month of June 2015. Given the data on food items for the month of July, it seems food inflation for the month of July would also continue to remain high. This is a worrying trend from a consumer's perspective, when the prices of essentials like pulses are showing a consistent rise..
The monsoons were erratic for the first half of July, but improved significantly towards the last week of the month. The overall deficit of the monsoons narrowed from 10 % to 5 % for June – July over its long term average. Due to this, the production of pulses, cereals and oilseeds are expected to be better than last year which should reduce inflationary pressure on food items in the coming months. The government is also importing 10,000 tonnes of onion from the overseas market to increase supply in the local markets. Global food prices being at 5 year low would also help the government to procure food items of which there is a shortage in the local markets.
Liquidity in the call money market increased due to government spending, purchases of US dollar by RBI in the forex market for the last one year in order to control rupee appreciation. RBI has been increasing rupee liquidity by buying US dollars. This created a liquidity surplus of Rs. 25,000- 40,000 Crores, which has to be absorbed. RBI announced an open market sale of government securities of Rs. 10,000 Crores on a multiple price basis. It accepted bids only for the short term and rejected all the bids for the long term. RBI has sent a clear signal it is not going to give higher yields in the auction to suck out excess liquidity from the markets.
US Fed Rate Hike
The U.S Federal Reserve chairperson indicated it would raise rates in the near term as unemployment levels in the US have fallen to 5.3 % levels and job growth has been solid. It indicated further pace of increase in fed fund rates would be data dependent and not continuous, maintaining a dovish tone of future rate hikes. This led to the 10 year yields moving up to 2.45 % levels during the month. However, soft data in terms of retail sales numbers and weak exports, mostly due to a stronger dollar, has again led to US bond yields retracting back to 2.25 levels.
RBI Monetary Policy
The RBI, in its monetary policy, has kept all the key rates unchanged. It has moved its CPI inflation forecast from 6.4 % levels to 6.2 % levels for the January – March 2016 quarter. As per the RBI model, it considers oil prices in the mid USD 50 per barrel levels, whereas Brent crude is trading at USD 50 levels for the last one month. The possibility of inflation being lower; exists if monsoon comes close to normal and commodity prices remains at current levels. The chance of commodity prices remains at subdued levels seems high due to expected supply of oil from Iran after lifting of sanctions and due to the ongoing slowdown in china.
We expect the RBI to cut rates by 50 basis points in the coming quarters, with the first rate cut coming in the next credit policy. Investors in duration products stand to benefit as interest rates are expected to moves down due to cut in key policy rates.
Murthy Nagarajan - The author is Head – Fixed Income, Quantum Liquid Fund & Quantum Dynamic Bond Fund
Data Source: Bloomberg, RBI