Long End Yields Rise Gradually

First, the factor that has always been the friend of the markets, the ample liquidity, is still available to the markets. The average liquidity has been to the tune of about Rs.5.50 Lakh Crs for almost a year now. The stance of the RBI that the growth factor precedes the inflation factor at this juncture would permit the liquidity to be there for more time. But there are clear signs that there may be some controls in future as the economy is preparing to migrate from a low growth to a more even growth in the next three to four quarters. Two actions from the RBI has been quite conspicuous in this context. The first was when the RBI hiked the CRR and took away money from the banks in the month of March and May of this year. It was free cash with the banks which got transferred to the RBI. The second and recent one is the desire of the central bank to hold variable rate reverse repos at frequent intervals. This would move liquidity from the banks and financial institutions to the RBI for pre-determined repo periods, and therefore, the same will not be available for any activity as such but would be locked away with the RBI.

The objective of the RBI is not just to withdraw liquidity in this case but to gently nudge the short-term rates to move up from the current levels. The short- term rates have been staying at levels a shade lower than the reverse repo rate. This action would define the floor for the money market rates in terms of the prevailing reverse repo rates and not lower than that. These factors which have been a part of the RBI policy announcements in the last three policy announcements present a weariness with the ongoing liquidity conditions while credit growth remains a challenge even as corporates report upbeat results. Second, the inflation level indicated by the CPI is marginally below the RBI’s threshold of 6 %. That this is close to the threshold and not far from there is a matter of comfort, but it becomes a concern if it sustains above this level for a longer time. Prices of essential articles have moved up significantly and more visibly the fuel prices. Fuel prices in international markets have moved down mainly as a result of stronger dollar but with a relatively weaker Rupee the adverse impact of fuel prices may linger on. The news about monsoon and the sowing season is normal and there is no need of any worries on that

front, and we have a good buffer of food grains. Therefore, to a large extent food price may be under control though protein rich foods and pulses may still be a weak links in the chain. Third, based on data so far and the ground level realities, in most parts of the world, there is an inflationary tendency, and this is attributed to, apart from fuel prices and demand, the pent-up demand from the pandemic period, revenge buying and spending, and also the holiday season and the availability of cash.

Central banks including the Fed have been maintaining that the inflationary situation may be transitory, and it may evaporate over time. But this may at best be a partially well-founded conjecture and high prices may sustain longer. In that case there is gong to be higher base rates and higher yields. The local economy is no exception. The long end yields have finally started to rise gradually. The new ten-year benchmark yield is at 6.25 % and it is poised to move higher. The targets may be 6.35 %, and thereafter, 6.60 %. This is singularly because the primary issues of the government is quite heavy this year exactly like the last and this supply may keep the yields at the long end higher. There are two factors that may have a dampening effect on the yields, one, a return of the pandemic, and two, a major cut in borrowing targets. The former is something to be watched closely, and the latter can happen only with buoyancy in government tax revenues which looks less likely at this time. Pressure may gradually build up at the short end too. Therefore, one should necessarily focus on very short-term products and avoid aggressive credit calls.
That is the only way to protect the portfolios against any value loss.


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