The measures announced in the Reserve Bank of India's credit policy have forced DSP Merrill Lynch to revise its fixed income strategy for May.
It has suggested that investors cut the average duration of their portfolio and retain more funds in cash during the month. This is a reversal of the strategy it advocated in April.
In its monthly report, DSPML has said, "We expect the market to weaken in the coming weeks and advise positioning for the weakening. The policy announcements are now behind us and have indicated a neutral tone. This will keep rate cut expectations subdued and the market is likely to be driven by demand and supply with falling inflation numbers triggering an improvement in sentiment."
It has further stated that the expected auction supply should take time to be absorbed and the market is not expected to strengthen during this period as there are no foreseeable positive triggers and auction demand is not likely to be aggressive.
"We expect the weakening to be sharper in the long segment (of the yield curve) and advise exiting positions recommended in the 2015-2017 and 2022 segments," the report said.
The report predicts easy liquidity and shifting market preferences will in all likelihood keep the short segments well supported.
The increased demand on this account coupled with the fact that there is no supply in this segment (up to 2012) is likely to keep this segment priced higher relative to fair value levels.
The initial signs of this can be seen in the sharply lower T-bill yields and even the 1-year
DSPML has also recommended segments such as 2007-2012 and also exposures to be concentrated in the 4-year (6.72 per cent 2012), 5-year (11.40 per cent 2008), 7-year (7.55 per cent 2010) with some exposure to 10.95 per cent 2011 and 9.40 per cent 2012.
"We maintain our recommendation of adopting a more active trading approach for the longer maturities as and when there are trading opportunities," the report said.
The report states that liquidity and inflation are likely to be guides for the medium term direction of yields and expect that the bullish undertones on this account could improve in the June-July period.
Moreover, it also believes that the 15-year segment is relatively cheap on the (yield) curve and is likely to outperform the 10-year and 20-year segments.
However, DSPML believes that positions at the long end may not be advisable. The very short segments could also underperform, given the current levels of around five per cent and below levels.
The credit segments are expected to see increased demand in May which could lead to a pick-up in yield and directed demand could cause spreads to tighten especially at the short end.
Yield pick up considerations are projected to come from expectations of a stable market while directed demand will come from the mutual fund segments that are witnessing flows in short maturity plans.
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