10-year yields may hit 7.50%

Trade friction among G5 nations, tame inflation readings, equities lower while bond yields retraced from their recent highs across global markets – marked the week that went by. The more dominant theme is the anticipation as to how Federal Open Market Committee (FOMC) will decide in the coming week when the US rate-setting committee meets.

In an unprecedented turn of events, President Donald Trump veers towards turning up the heat on China trade. With estimates ranging between $30 billion and $60 billion in retaliatory tariffs, the administration targeted the Chinese technology and telecommunications companies. The tariffs could be imposed in the very near future as a follow-up to a months-long investigation into China's trade practices. The tariffs imposition also extended to Canada on imported paper. Overall, an eerie of uneasy calm pervades global markets. Yields on 10-year US Treasury notes fell 5 basis points (bps) to 2.85%. WTI crude was broadly unchanged while volatility remained flat week over week.

On the data front, both the US and Eurozone disappointed on the inflation readings. Eurozone consumer price gains were revised lower to just 1.1% year over year. The slowing inflation rate could call into question market anticipation that the European Central Bank (ECB) will end its quantitative easing program late this year. In the US, retail sales data for February left analysts wondering if the strong growth estimates will materialise. Q1 growth projections have been revised lower, therefore. FOMC is widely expected to raise rates in its March meeting if one were to go by the over-85% of market probability attached to rate curves.

After nearly three months, the Indian markets had reasons to cheer on the data front. We had the rare combination of higher growth and lower inflation, data released last week suggested. IIP data showed that India's industrial growth accelerated in January. Industrial production growth rose higher than expected to 7.5% in January from 7.1% in the previous month, led by strong manufacturing. On the retail inflation front, CPI eased for a second month running with a reading of 4.44% against 5.10% the previous month. This is the lowest reading in four months. Wholesale Price Index (WPI) also softened month over month and the February readings came in at 2.18% as compared to 2.84% the previous month. Core inflation, however, remains flat.

With barely two weeks to go for the year-end and speculations rife that some forbearance may come in for the investment portfolios of the banks, which have been down by about 200-250 billion rupees in valuation, bond yields softened marginally. At current levels, the benchmark yield is still higher by about 40 bps over December levels. RBI has addressed the issue of market liquidity with a 1 lakh crore repurchase of short tenor bonds. There was a tepid response to one such auction last week. Most of these buy-back bonds may have a money-market-like profile and would be a better bet than reverse repo or term reverse repo. Hence the response could be damp.

Traders are also betting on prospects of an increase in FPI limits for government securities. While the probability is undoubtedly high, the timing will make all the difference to market sentiment. 10y benchmark yield should drift gradually towards 7.50% in near term.

EYEING INFLOWS

• With barely two weeks to go for the year-end and speculations rife that some forbearance may come in for the investment portfolios of the banks  
• At current levels, the benchmark yield is still higher by about 40 bps over December levels