Iran risk; FX; India’s headwinds
Risk-off sentiment receded as investors looked past geopolitical tensions towards upside surprises in data. The euro regained its footing after the Sentix hit a 2-year high in January on lessened trade/Brexit tensions and pushed back recession fears. The British pound is holding ground above 1.30 ahead of Brexit Day on January 31 but is in no hurry to rally. Scepticism remains high that UK will be able to negotiate a future relationship by the end of the transition period that ends on December 31.
On safe haven trades, gold is preferred as a safe haven over the Japanese yen. Investors remain wary that, like trade relations, US President Trump has a penchant for escalating tensions to the brink without triggering an all-out war. While a lower USDCNY below 7.00 improves risk appetite, higher Brent crude prices above USD70/bbl fan risk aversion.
India: Geopolitics and higher oil weigh
Weak global sentiments lifted INR sovereign bond yields on profit-taking bids. The jump in 10Y yield was, however, modest vs past risk-off episodes, likely due to expectations that the central bank will be inclined to step-up buy-sell OMOs in the coming weeks, to cap long-term yields. 10Y yield rose 5bps to 6.56% on Monday but is still >20 bps below December 2019 highs. 2Y yield held steady.
The RBI has conducted three tranches of buy-sell open market operations (OMOs) in the last fortnight; latest was Monday with IN100bn worth op-twist. Sub-target revenue growth increases the scope of additional borrowings this quarter. This might necessitate 1-2 more tranches of OMOs ahead of February’s Budget. We expect 10Y yields to stay supported above 6.5%, maintaining a 80-100bps premia over shorter-tenors, leaning towards a flatter curve.
The rupee and equity markets took a hit yesterday, akin to EM peers. Markets view the rally in Brent oil prices, triggered by geopolitical tensions, as a threat to the improvement in India’s FY20 current account deficit (DBSf: -1.4% of GDP) and forecasts for a BOP surplus (see here), besides other macro risks. Downbeat sentiments saw USDINR test past 72 to two-month high, while the benchmark equity indices ended in red. Persistence of this spurt in oil prices will be watched closely.
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