The intrepid bulls continued their rampage on the bond markets as yield on government bonds dipped to fresh lows. Call rates continued to rule around 7% during the week, belying fears of tighter liquidity on the back of advance tax outflows. Coupon payment and redemption of government securities, coupled with the return of advance tax outflows boosted money supply in the system. The RBI's open-market sale of Rs 4000 crore (11.03% 2012) was lapped up in few minutes, indicating the surfeit of liquidity.
Bull Fervour Refuses to Ebb
After discounting a 50 basis points cut in the bank rate, markets are now speculating on a full 1% cut in interest rates to spur a weak economy. The surfeit of liquidity with no auction announcement for third consecutive week ensured that bond prices continue their northward journey. The players' hope for a sharper rate cut is supported by grave decelerating numbers, which continue to paint a grim picture. The core sector growth was a negative 0.5% in May 2001 against 8% in May last year.
Yet, while industry and market players are rooting for a rate cut, there is little evidence to suggest that rate cuts earlier in the year are driving any credit off take. While a few triple A-rated corporates have mobilised Rs 1,200 crore in the current calendar, a whopping Rs 845 crore (70%) has been cornered by the two oil companies of BPCL and HPCL. Well, then the million-dollar question is that while you can take a horse to a pond, can you make it drink? Curiously, while industrial growth continues to slump, both government and market players are in a win-win situation amidst softening interest rates. While its cheaper resources for the exchequer, banks are making fat gains on their G-sec portfolios.
However, if the monetary stance fails to re-charge the economy, government will have little option but to take larger initiatives on the infrastructure front and pump money. While results will take time to show up and fiscal numbers are bound to go awry, this is at least expected to kick start demand in the economy.
It is a decisive week for the bond markets with the crucial FOMC meeting scheduled for June 27. While a rate cut is on the cards in the US, it is crucial that the RBI either pre-empts or follows suit at the earliest. Any delay here is bound to puncture the feel-good factor and trigger a sell-off in an overheated market. Already, players have started to develop cold feet on the prospects of the historic bull-run and are reducing their portfolio maturity. On the whole though, liquidity is expected to be comfortable for the next two months with inflows of Rs 31,000 crore by way of coupon inflows and redemption of G-Secs. Thus, after a brief hiatus, this period is expected to see acceleration in sale of sovereign bonds.
On the other hand, the rupee is currently overvalued by around 4% in real terms and could see some depreciation to maintain export competitiveness. While this is important, especially with the slowdown in export growth, it could mar the positive sentiment in the bond markets.