Wednesday, May 04, 2011 14:16 Hrs IST
We expect 3M bank CD yields to gradually trend towards 9.50-9.75% pa
Dhawal Dalal Senior Vice President & Head - Fixed Income DSP Blackrock Investment Managers
Market Reaction towards Annual Monetary Policy Review on 3 May 2011
Market participants found the RBI's tone and language a bit hawkish than past credit policy tones. Clearly, for the RBI, the priority is to rein in headline inflation as early as they can even at the cost of lower growth going forward. This is a marked departure from their previous Monetary Policy stance of supporting growth while containing inflationary pressures. The RBI has acknowledged that apart from higher global commodity prices, the single important risk may be higher oil prices that will test the assumptions of the budget estimates for the FY2011-12. The RBI is cognizant of the fact that if global commodity prices remain at current level for a longer period, then it will have significant negative implications on government finances going forward.
Given this backdrop, the bond market's initial reaction was cautious. The benchmark 10Y yield hardened from 8.14% pa before the Policy to 8.21% pa after the Policy. The 5Y OIS level also hardened by 10 basis points to 8.35% pa.
We expect bond prices to remain range-bound with a declining bias in the near-term as market participants may await a revision in the fuel prices and its impact on headline inflation. A lot depends on the trajectory of economic growth and the monsoon, going forward. Although there is perception of a slowdown in the overall economy, market participants are not sure if it is a mid-cycle slowdown, which may result in more rate hikes later when economy accelerates or a cyclical slowdown, which may result in the rates being closer to their peak levels.
What should an investor do?
We expect the yield curve to flatten more in the near-term. A 50 basis-point hike will gradually push short-term rates higher. We expect 3M bank CD yields to gradually trend towards 9.50-9.75% pa from their current levels of 9% pa. 12M bank CD yields may touch 10% pa in the near-term. Given the fact that banking system is likely to see pressure on their profitability due to the Credit Policy, we expect banks to raise both deposit rates as well as lending rates in a gradual manner. Therefore, it makes sense to remain invested in a low duration funds at the moment and wait for money market rates to peak out in the next three to six months before seeking to extend the duration of investments.
DSP BlackRock Liquidity Fund as well as DSP BlackRock Money Manager Fund are, we believe, well positioned to benefit from a rising interest rate scenario in the near-term. Both Funds have around 40% of net assets maturing in the month of May 2011, with an average maturity of 29 days and 33 days respectively.