Tuesday, June 21, 2011 11:06 Hrs IST

We Expect Money Market Rates to Trend up in a Gradual Manner

DSP BlackRock Mutual Fund – Debt Market Views

The Benchmark 10 Yr government bond yield moved down sharply from 8.41% pa in the beginning of the month to 8.25% pa as on 17 June 2011 as appetite for securities has improved as RBI has not taken any strong action at its mid-quarter policy review, despite inflation overshooting beyond the central bank's comfort level. The RBI has raised Repo rate and Reverse Repo rate, both by 25bps to 7.50% and 6.50% respectively. The market was relieved by the small quantum of monetary tightening as a higher-than-expected May Inflation numbers had battered sentiments in the past two sessions.

Money market rates softened in May on account of lack of supply and strong demand from Mutual Funds. 3M Bank CD yields moved from around 9.8% pa at the beginning of the month to around 9.0% pa as of June 17, 2011. 12M Bank CD yields moved from 9.9% pa to around 9.75% pa during the same period.

Based on the new series of index numbers of industrial production with 2004-05 serving as the benchmark, the growth rate of factory output has dipped to 6.3%in April 2011 from 13.1% during the corresponding month of the preceding year. Among the industry groups that have registered a high rate of growth during April 2011 were food products, paper, basic metals, office, accounting and computing machinery, motor vehicles, trailers and semi-trailers and other transport equipment.

The WPI headline inflation rose an annual 9.06 per cent in May, driven by higher manufactured goods prices. The figures showed that the manufactured products index, the largest constituent of the wholesale price index shot up 7.27 per cent, while the primary articles index rose sharply by 11.3 per cent. The index of food articles too increased by 8.37 per cent in May.

The liquidity in the system continues to remain tight and is on average Rs. 60,000 crore in deficit.

Outlook

Bond market participants are cautious amid high credit offtake, geo-political uncertainties and rigid headline inflation.

We expect benchmark 10 Yr yield to remain range bound with an upward bias keeping in mind the recent rate hike by the central bank and elevated inflation levels. We expect to see the 10Yr trading in a range of 8.20-8.40% pa at its peak.

According to RBI, headline inflation currently underestimates the pressure because domestic fuel prices have yet to reflect global crude prices. Monetary Policy to remain ‘firmly' anti inflationary and some short term growth deceleration will be inevitable in bringing inflation under control. Growth is already slowing as indicated by service PMI and industrial output.

Money market rates have seen some softening due to strong buying from MFs. We expect money market rates to trend up in a gradual manner due to the anti inflationary and restrictive monetary policy stance maintained by the RBI.