As suggested in that note, 10 year benchmark in anticipation of further rate hike expectations have inched up from 7.65% to currently closer to 7.70% levels.

What is the way going forward from hereon:

Negatives in the market:

1. Inflation to further rise to closer to 12.25 to 12.50% & peaking off at these levels
2. Maybe erratic monsoon as seen in some of parts of the country & its repercussions
3. Further rate hikes in the future (taking the overall rate hikes for the year to between 125 to 150 bps as compared to last year)
4. Since 2003 when the interest rates were at their lowest & thereafter either remaining steady or only going upwards, Short Term Schemes as an asset class has outperformed long term GILT & Bond Funds on 1/2/3/5/7 year time horizons; dissuading clients to take unnecessary duration or interest rate calls

Positives in the market:

1. More than expected hefty revenue collections from 3 G/BWA Auctions, better than expected tax collections due to better corporate results. This still does not include any revenue collections from PSU disinvestments
2. Mechanism announced to free the petroleum pricing; thereby hugely reducing petroleum subsidy figures
3. Possibility of more foreign inflows expectations due to up gradation of GDP numbers by IMF
4. IIP numbers easing from a high of 16.5% to currently at around 11.5% & likely to go further down to single digit figure
5. After peaking off at maybe 12.50%; inflation to soften due to base effect kicking in & going to higher single digit by September & to approx 6-7% by March 2011
6. Demand/Supply of G Sec becoming more skewed in favour of demand in the year 2010-2011 than supply (reverse was the case for FY 2009-2010)
7. In almost 6-7 years’ deposit growth is much lower than the credit growth. This can be attributed to aggressive borrowing by the Telecom Companies & also aggressive borrowing by corporates at large before the Base Rate policy becoming applicable on August 01’2010
8. Even though there is merit in the argument that Short Term as an asset class has outperformed long term bonds or long term G Secs; there have been periods in which long end of the curve has hugely outperformed any other asset class including equities. Typical example is when we had recommended investment in long end in November 2008 & thereafter we had given an aggressive disinvestment calls between December 2008 end and January 2009 beginning by which time the investments in long term G Sec schemes had been hovering in the region of 20-25% absolute returns
9. Hence, even going forward, one will have to be nimble footed and take advantage of this trading zones which comes up every once in a while
10. I personally believe that we are in that trading zone range, wherein investors investing at current levels of 7.69-7.70% levels can expect, for reasons mentioned above, 10 year benchmark to soften further to between 7-7.25% levels by March 2011
11. One need not literally have one year view and hold onto these investments for one year. Investor need to cash onto these opportunities & redeem (even if there are exit loads applicable in some long term bond funds) as & when they have managed to earn more than expected returns from this asset class

Though short and medium term rates have not moved up today, the same will start inching up closer to dates of CRR hikes in February. Same will be the case when advance tax outflows kick in during March 2010. This is the time when yield curve will start to flatten from its current steepness (when 1-5 year yields will start moving up). Long end of the curve is (as expected) not likely to be impacted so much.

What were the key announcements & Forecasts?:

How does one read into RBI’s move of increasing CRR by 75 bps & not touching the benchmark rates?

What are the milestones post this Policy Review which can affect the debt markets?:

Hence, I see this Policy as a sigh of relief as immediate negative news is behind us (without impacting markets too much). Also this should give some insight into the mind of RBI (wherein they wish to see accelerated growth) & hence may not be in a real hurry to increase rates.

Impact of this liquidity tightness during February (when CRR hike takes effect) & advance tax outflows happen in March 2010, will be reflected in Short Term Plans for a short period of time. This asset class will have some negative impact before bouncing back post March 2010. On the other hand, if fiscal numbers for next year are on the positive side (with an assumption that RBI might not raise rates in hurry to achieve accelerated growth), long end of the curve should start rallying post March 2010. Another factor which can impact the long end positively is that Govt has almost finished their borrowing programme for the current year.