Bullish on bonds in next 3-6 months: Upasna Bhardwaj, Kotak Mahindra Bank

In a chat with ET Now, Upasna Bhardwaj, Economist, Kotak Mahindra Bank, says OMOs plus one rate cut hope will probably provide room for another 20-25 basis downward move on the 10-year bonds. Edited excerpts


How will all the macro variables be connected on account of what happens with the US presidential elections particularly the impact that we would seen on world bond as well as the currency markets?

The neck and neck fight between the two US presidential candidates together with the fluctuationg opinion polls, has been providing the jitters on the markets. The markets are still believing that it is the Democrats who would be winning and that is where the base case assumption is.

It is little difficult to gauge exactly how things would be post the outcome if it is a clean sweep for the Democrats then probably we do not really expect much of a move except for a knee jerk positive reaction initially and then everything settles down to status quo.

But of course if it is a Republican win, then we could be bracing ourselves for some kind of a volatility for a much longer period of time especially with the kind of protectionist policies that Trump has been talking about. There is a lot of element of uncertainty at the moment but markets are inclined to go with a belief that Democrats would be winning.

Join the dots here. What would it mean for India because that is the story that matters to us?

The Republicans have been talking about protectionist policies and if they were to be implemented, we may not be directly impacted but the indirect impact on India would be pretty high. This is particularly because it is about exporting not of just goods but exporting goods, capital, labour etc.

A large part of India’s current account deficit gets compensated by a surplus on the invisible side and that might take a hit if Trump comes to power and protectionist policies are implemented. So it is not going to be positive for India in that sense. On the other hand, in case of Hillary win, there will be a brief knee jerk positive reaction. A Trump win initially will be negative and the Indian bond markets will probably react negatively with the yields going up by three to four basis,

On the other side we could see a downside to yields if it was Hillary who was to win. The dollar rupee ratio will remain more or less stable if with a slight appreciation bias initially but otherwise dollar has to weaken against majors if Trump emerges winner.

Most of the EMs who are exporting countries, will see their currencies take a hit and hence there could be a indirect impact on rupee as well if Trump was to win. So there is going to be some kind of a new normal which we will have to settle once outcomes are in place but over the medium term, if the Republicans were to win and those policies that are being talked about are going to be implemented, it will be negative for most of the exporting countries including India.

What do you expect the Indian yields to do in the near term irrespective of Trump ascendency. Other things are happening around us. S&P may take a different view but the latest cues that show that some improvements are being sighted In India. What is your view?

Barring the global event that we are talking about, domestically, we have other events to watch out for. We have our upcoming inflation readings to which the bond markets would be reacting and now going forward, the next few readings are likely to be fairly benign.

There is a possibility of a sub 4% CPI reading which will be positive for bonds. Besides that, in turn will trigger a higher probability of a rate cut in December itself by RBI. So that should be supportive for bonds.

At the same time, given that the domestic rupee liquidity is so tight, we expect most of November to be tight in terms of rupee liquidity. Currency in circulation has been one of the reasons for the lighter liquidity in October. At the same time, we have about $12 billion of FCNR outflow in November and the data available shows there is a $4-5 billion shortage in terms of the hedge books.

So, that kind of a shortage will also have a bearing on domestic liquidity. That in turn should prompt a need for OMO purchases. We are looking at a benign inflation and OMO purchases scope to provide support to bonds. If we are looking at a three months to a six months horizon, then I continue to remain bullish on bonds but not a very steep rally because the kind of runaway rally that we have already seen, would no longer take place but OMOs plus one rate cut hope will probably provide room for another 20-25 basis downward move on the 10-year.