Post RBI monetary policy views

Part 1: G-secs

The big news in todays announcement is the increase of Open Market Operations (OMO) from Rs. 10K cr. from Rs. 20K cr. Few questions that guide our views:

(i) Whether RBI would be able to mop up this size every week. We have seen in the past RBI announcing less than Rs. 10K cr. of success in auctions.

(ii) Whether these OMO will happen weekly, or will become more intermittent.

(iii) Whether RBI will continue with Rs. 20K cr. auction even if yields drift much lower.

(iv) Whether RBI will curtail it's secondary purchases, now that auction OMO size has increased.

Without doubt, the OMO is positive for the markets, however how the above questions pan out with time would significantly alter the bonds rate trajectory. We believe that:

(i) The best case scenario of Rs. 20,000 cr + secondary market purchases is unlikely as that would mop up nearly all of G-sec supply of 28K.

(ii) Most likely, the secondary market purchases would be yield dependent.

(iii) Thus when yields trend higher, RBI could end up mopping up most of the supply, but at lower yields the markets demand would be sufficient.

In short, chances are that the increase in RBI OMO may not be simple delta of Rs. 10K cr., since (i) secondary market OMO purchases might come down, (ii) RBI may not mop up Rs. 20K cr. in every auction, (iii) this may not be a weekly auction. However, it is probably good as that would leave meaningful supply for market participants.

Trading View:

We maintain our two trades:

Trade 1: Contrarian

We continue to play contrarian in 10y - and would prefer to buy when the yields go higher, but will temper our expectations when yields move lower. However the range might drift lower and thus we would prefer to wait closer to 5.85-80% (instead of 5.90%) yield before we think about shorting. Moreover until there is clarity on questions posed on OMO, we would refrain to run shorts. For the time being, we prefer to run longs in belly.

Trade 2: Long 2y-5y tenor

We prefer to remain long in 2y to 5y segment, especially since the Governor mentioned that accomodative policy to continue into next fiscal year. Having said that, inflation and growth predictions are dynamic, and we understand that views would be based more as underlying macro unfold.

Part 2: OIS

View: Pay 5Y 4.30 - 4.55

The policy reaffirmed the fact that if OIS drifts higher, the cost of carry loss is signifcant if the rates do not move higher. A year of accomodative stance and there is a significant loss of carry. With no trigger in foreseable future for OIS to move signifcantly up - we do not see a reason to pay the OIS. The view is even more entrenched when we see that there could be rate cuts - however low the probability. Nonetheless that does not mean that we are comfortable recieving at these levels, as the rates are near all-time low.