Inflation ! oh Inflation !! – Rates hiked beyond expectation… Well this was the state of the market yesterday post RBIs surprise 50 bps rate hike. There was consensus of a 25 bps rate hike in July and one more in September (our view too), and then probably a pause till further clarity from incremental data emerges. What then has prompted the RBI to hike 50 bps and do a repeat of July 2008 where rates were hiked in a similar fashion ?
Following could be the key reasons
- Inflation likely to remain stubbornly high, including food inflation if monsoon situation would worsen
- Commodity prices continue to rule high, and could be further accentuated if there were QE 3 announced. Global crude prices also could see some upside in a situation of recovery in advanced economies
- Concern over incomplete pass thru of higher global crude prices into domestic fuel prices
- Undercurrents of strong demand which continues despite an effective policy tightening of 425 bps since Oct 2009
- 'Being behind the curve' impression of the market (about RBI)
In line with the above, the RBI has also revised its March end WPI projection to 7% from the earlier 6%. Also, the money supply growth and non-food credit growth have been revised downward to 15.5% and 18% respectively. This we believe could have been prompted by the fact that higher rates would dent demand.
Our take on the policy
We believe that the RBI could have done rate hike in 2 tranches of 25 bps each between now and September as the end of the tightening cycle is almost a consensus view. This is also evident from the incremental data being released which is surely showing some signs of moderation, if not collapse. Though the inflation numbers are high, the reality is that there is a lag in monetary transmission to the real economy and to that extent aggression towards the fag end may not be well appreciated as was evident on the sharp market correction – both fixed income & equity.
However from the RBIs perspective, they are of the view that the demand slowdown is not all pervasive and growth expectation is still at around 8%, therefore this action is not likely to derail growth significantly. For sure the policy has been guided by 'anti-inflation' agenda in mind.
Can RBI afford to do 1 more rate hike on 16th September ? The RBI has clearly stated in the policy document that " The monetary policy stance will depend on the evolving inflation trajectory, which in turn, will be determined by trends in domestic growth and global commodity prices"…..
Our inference from the above is that future rate action would be data dependent and hence too early to form a judgement on the same. However, we would want to reiterate our view that the rate tightening cycle should be done with in the 1st half, and that this could be front loading of the intended tightening. To that extent it would not be surprising to see a pause in the next review, unless global/domestic developments warrant otherwise
Market view & Our product positioning
Most of our duration funds like Kotak Bond Short term, & Kotak Credit Opportunities were low on duration and hence have not been adversely impacted on a relative basis. We continue to maintain that for less than 1yr horizons, open ended funds with durations around 1year should be preferred over lock in strategies like FMP. The yield curve has moved upwards by 15-25 bps as the market was prepared only for a 25 bps hike in rates.
The curve is expected to stabilize around these levels. We expect liquidity situation to be in the deficit mode of around 50,000 cr till advance tax scheduled in mid September. There are evidences of initial reduction in credit off take and hence we do not expect a significant upward pressure on the yield curve. Also, corporate bond spreads do look attractive and we would look for opportunities across the corporate bond yield curve, especially in the 2-5yr segment.
We would continue to recommend Kotak BST with a 3m investment outlook. The portfolio would manage a duration of 6-7months and the current portfolio carry yield is around 9.90%. Kotak Credit Opportunities has a duration of around 1year with a carry yield of around 10.50%
10yr gsec is hovering at 8.45% levels (backed up by 13bps post policy). While we do not expect the 8.5% mark to be breached, we also do not expect a secular decline in gsec yields. At best we should see a range bound trading market, till we get clarity on the 2nd half borrowing programme and slippages if any on account of fiscal deficit. Till such time, on a risk reward basis, we would be more comfortable recommending long term FMPs over duration strategies like gilt and bond.
RELIANCE EOD CHART 28 JULY 2011
TATAMOTORS EOD CHART 28 JULY 2011
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