The Times They Are A-Changin

Fri 11-Nov-2016 07:55 AM
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Rahul Pal

Head - Fixed Income

Bob Dylan lingers on as we pen our thoughts. As the Nobel Prize for literature for 2016 was awarded to the singer “for having created new poetic expressions within the great American song tradition “, we could not but help recollect his 1964 classic “The Times They Are A- Changin” as a reflection on the state of capital markets.

Amidst the strong euphoria in the markets, we remain watchful: have they gone ahead of the fundamental factors which drive the markets? Our newsletter will try and portray the "changin times".

The Martinet with The Kid Gloves

Dr. Urjit Patel was deemed as a martinet in his battle against inflation. Yet, as he presented his first monetary policy, within the new construct of Monetary Policy Committee, it seemed that he took out the kid gloves with a cut of 25 basis points in the Repo Rate. The commentary and the press briefing which followed also revealed a potential lowering of the real interest rates band to 1.25 -1.50 percent from the earlier stated target of 1.50-2.00 percent. It also reaffirmed a continued stance of accommodative bias with the move towards liquidity neutral target remaining intact.

The Markets

Bond and Money Markets

We present a matrix detailing movements in some key market rates (domestic and global) and key economic indicators:

Source: Bloomberg

It appeared that the bond markets were quiet: yet beneath the quiescent market was a subtle upward bias on rates. The benchmark 10 year gilt, which fell sharply to around 6.65% post the monetary policy , hardened by around 12-15 basis points(bps) to close at 6.79% at the end of the month, predominately tracking a sharp rise in global yields.

Domestic liquidity also tightened due to seasonal factors like increase in currency in circulation, telecom auction payouts and partial maturity of the FCNR deposits. This led to a marginal upward bias in extreme short term rates with rates moving up by around 20 bps while 1 year money market rates fell around 12-15 bps tracking the repo rate cut.

Equity Markets

We present charts tracking domestic index and sector, and global indices movements

  • Indices declined 1% over October, performing in line with its peer in the emerging markets.
  • FIIs turned sellers of US$616m of India Equities in October, after seven consecutive months of being buyers. Mutual funds bought US$ 1.2 bn of equities. Energy and utility sectors did well owing to the improved outlook of the underlying prices.

    In terms of macro events,
  • The GST Council was unable to reach a consensus on rate structure in the October meeting.
  • Q2 earnings so far have been mixed with a noticeable beat coming from the Consumer Discretionary sector and retail banks.
  • IT & corporate banks underperformed, largely owing to disappointing results and outlook.

Data Hangover

  • Retail Inflation for September 2016 indexed to CPI fell sharply to 4.31% marked by a sharp drop in food price inflation to 3.88%.This drop in inflation was predominately led by the vegetables subcomponent (having a weight of 6.04% in the index) which printed a number of -7.21%.
  • However the core inflation remained flat and with a sharp upswing in commodity prices, the assumption of a secular benign inflation may be at risk as we move forward.
  • The Fiscal Deficit for April –September 2016, at INR 4,47,988 was at 83.90 % of Budget estimates.
  • This is the highest in a decade. While the deficit may appear to be front loaded because of fall in non capital receipts of the Government, this may cause a stress on the liquidity in the system due to mismatch in receipt and expenditure flows.
  • We present a matrix of certain real economy numbers:


The "Changin" Times

We maintain an argus eye and remain watchful of certain underlying developments in the capital markets. We reflect on certain themes:

Rising Global Yields

We present a small matrix comparing movement of some global yields during the month.

Source: Bloomberg

There has been a sharp rise in Global Developed and Emerging market bond yields. While it remains too premature to call it a secular trend, we cannot ignore the possible bearings such spikes may have on easy liquidity prevalent throughout.

The Depreciating Yuan

Rising Raw Industrial Prices

Source: Bloomberg

The Raw Industrials index within the Commodities Research Bureau (CRB) index has inched upwards from December 2015. While this has yet to feed into output price increases, it can potentially alter the domestic benign inflation which is being forecasted by policymakers.

Softening Demand and Potentially Slowing Volumes

The last five years have witnessed the consumer staples and discretionary space a volume growth of high single digit and high single digit pricing growth. However in last three quarters, we have witnessed a pricing decline and a muted or negative growth in volumes. Whist it is too early to read it as a signal, we remain watchful in this space.


The midcap indices are currently valued at 2 Standard Deviations(SD) five year average and large cap indices are valued at 1SD five year average, one of the reasons could be that earnings have not grown for last three years and the hope still remains that earnings could grow higher double digit in next two years.

Quo Vadis

Debt Markets

The extreme short term rates, despite a rate cut, have shown an uptick during October. However, spectrum auction, maturity of FCNR (B) deposits, lower government expenditure and possible busy credit season may keep a tight leash on liquidity thereby possibly creating an upward bias of short term rates.

The buying of sovereigns through OMO and the collateral liquidity may help short term gilt rates to remain benign. With spreads of AAA rated corporate too trading at narrow spreads, there remains a probability of short term gilt rates offering a better risk return trade off. Further there exists a possibility of lower printing of headline inflation numbers thereby helping the possible easy bias in the sovereign yield curve. While there has been some hardening in cement, steel and pet coke prices and other commodity prices like that of Zinc, they haven’t percolated through retail inflation. We would keep a close track of these prices on the potential inflation trajectory.

Equity Markets

The month of November is very crucial for equity markets both in terms of flows and future earnings outlook. The three important data points are GST council decision on the rates, US presidential elections and data points for US economy which will be the deciding factor for Fed Rate decisions in December.

Currently in India the valuation of midcap/large cap is at all time high. So earnings momentum is necessary in India centric companies for prices to sustain in midcaps. Post second quarter numbers we don’t see significant downgrades in earnings but the current prices reflect +1SD multiples average for the last decade. We are watchful and intend to look at pockets where there could be positive earnings surprises.


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