Rising Fuel Prices, Labour Shortage, Import Bans to Push Up Inflation

Rising Fuel Prices, Labour Shortage, Import Bans to Push Up Inflation

Bond Market Snapshot For The Week

• New 10 year benchmark yield closed at 5.90%, up by 5 bps on a weekly basis
• 5-year OIS yield rose by 5 bps to 4.18% on a weekly basis
• CCIL SDL Index closed at 6.51%, up by 1 bps on a weekly basis
• Liquidity continues to be in surplus at Rs 2.77 trillion

Lower global crude oil prices have had an opposite effect on retail fuel prices, with the prices rising by more than 12% over the last one month. The government desperately requires revenues given the economic slowdown on lockdown and is targeting duties from fuel as a source of revenue.

Given higher fuel costs, the prices of food increases as the cost of transportation rises. This will hurt CPI inflation with both fuel and food inflation levels rising.

The reverse migration due to lockdown has caused huge labour shortages across industries and the cost of labour is rising given the need to continue production and services. Many sectors are operating at low capacity largely due to labour shortage and this is hurting supply of goods and services. This is also pushing up costs in urban areas.

The government is considering imposing bans and higher import duties on imports from China. This will push up costs in the economy given that domestic produces can get back some pricing strength and also due to the fact that raw material costs will rise for industries dependent on China for supply. Inflation will rise if the import ban and higher duties are imposed.

The heavy supply pressure coupled with higher inflation expectations pushed up yields on benchmark bonds and levels will stay higher unless there is direct intervention from RBI through OMOs.

The new benchmark 10-year bond, the 5.79% 2030 bond, yield rose by 5 bps to 5.90% on a weekly basis. Old benchmark 6.45% 2029, yield remained unchanged at 6%. New 5-year benchmark 5.22% 2025 yield declined marginally to 5.17%. The old benchmark 5-year bond, the 6.18% 2024 bond, yield came down by 8 bps to 5.03% while 7.17% 2028 bond yield decreased by 3 bps to 6.01%. The 6.68% 2031 yield level increased by 2 bps to 6.26% on a weekly basis. Long term paper 7.16% 2050 yield rose 1 bps 6.60%.

One-year OIS yield rose by 2 bps to 3.65% while the five-year OIS yield increased by 5 bps to 4.18% on a weekly basis.

System liquidity as measured by bids for Repo, Long Term Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI, drawdown from Standing Facility (MSF or Marginal Standing Facility) and CMB was in surplus of Rs 2769 billion as of 26th June 2020. Liquidity was in a surplus of Rs 2361 billion as of 19th June 2020.

Jitters Over Second Wave of Covid-19 Cases Keep Forex Markets Volatile

Currency Market Snapshot For The Week

• INR appreciated by 0.73% against the USD last week and appreciated by 0.60% against the euro.
• USD fell by 0.19% on a week on week basis and is at a level of 97.43.
• The British pound depreciated by 0.11% against the USD
• Euro appreciated by 0.37% against the USD.

Global Bond Market Snapshot For The Week

• US 10-year benchmark bond yields fell by 5 bps last week.
• German 10-year bond yield fell by 7 bps and is at negative 0.48%, French 10-year bond yield fell by 4 bps.
• Italy's 10-year benchmark yield rose by 4 bps to 1.36%.
• US benchmark Junk bond yields rose by 27 bps to 6.69%

INR ended the week higher against USD last week, as the risk sentiment improved in the early part of the week after U.S. President Donald Trump cleared that the China Trade deal is fully intact as long as China continues to live up to the terms of the agreement. Sentiment for the INR also improved during the week after media reports quoted Indian Army sources saying Indian and Chinese forces had agreed to "disengage" at the border in eastern Ladakh, the site of a recent violent stand-off between the two armies. INR appreciated by 0.73% against the USD last week and appreciated by 0.60% against the euro.

INR was additionally supported by foreign investments into Jio Platforms. Earlier in the week Reliance Industries informed exchanges that Saudi Arabia's Public Investment Fund would invest Rs 113.7 billion for a 2.3% stake in Jio Platforms, which amounts to nearly USD 1.5 billion at the prevailing exchange rate. This was after series of investments worth nearly Rs 1.15 trillion taken place in the last couple of months.

USD ended the week lower against major world currencies last week on market participants worldwide building hopes for a global economic recovery despite jitters over the fresh wave of Covid-19 cases amid expectation that the major central banks are likely to continue providing monetary support to bolster economic growth. USD Index (DXY), which tracks the movement of the USD against six major currencies, fell by 0.19% on a week on week basis and is at a level of 97.43.

USD witnessed high volatility in the early part of the week after White House trade advisor Peter Navarro said that the US-China trade deal was over on Monday, only to issue a clarification shortly afterward stating that his comments had been taken wildly out of context. U.S. President Donald Trump provided further assurance after he tweeted that the deal was still intact.

Late Thursday, the US Federal Reserve relaxed regulations for big banks to make large investments in funds such as venture capital funds that boosted sentiment for riskier assets such as stocks. Further, on Thursday the Fed in its annual stress test, said US banks were strong enough to endure the COVID-19 crisis, but limited dividend payments and share buybacks would help banks to preserve capital.

Weekly Global Bond Market Analysis
US 10-year benchmark bond yield fell by 5 bps last week and is at 0.64%, the sharp fall in the yield came on Friday as the market grappled with record rise in new U.S. COVID-19 cases, concentrated across southern and western states, with some governors halting business reopening plans.

In U.S. economic data, consumer spending climbed in May to a record 8.2% after tumbling in April, however, personal incomes sank 4.2% last month.

Eurozone bond yields were largely down last week. German 10-year bond yield fell by 7 bps and is at negative 0.48%, France 10-year bond yields fell by 4 bps and is at negative 0.13%. Italys 10-year benchmark yields rose by 4 bps.

US benchmark Junk bond yield rose by 27 bps and is at 6.69%, Euro benchmark Junk bond yields rose by 13 bps to 4.57%.