Steep 5*10 Spread is an Opportunity and a Threat

Steep 5*10 Spread is an Opportunity and a Threat

Bond Market Snapshot For The Week

• New 10 year benchmark yield closed at 5.76%, down by 9 bps on a weekly basis
• 5-year OIS yield rose by 1 bps to 4.16% on a weekly basis
• CCIL SDL Index closed at 6.42%, down by 8 bps on a weekly basis
• Liquidity continues to be in surplus at Rs 3.03 trillion

RBI has been aggressively buying USD to prevent an INR appreciation and this is driving down yields across the yield curve. However, short end yields are down sharply with 5*10 segment of the curve spread at 92bps indicating the liquidity effect of fx purchases. RBI has bought USD 35 billion of fx, April to date, and has added Rs 2.2 trillion of liquidity into the system. Read our currency market report for details.

RBI is intent on keeping interest rates at record lows and keeping down bond yields in its support to the economy. The heavy infusion of liquidity is driving down yields to lows at the short end and is also filtering into yields at the longer end of the curve.

Central government and state governments will become more dependent on market borrowings to fund the fiscal gap, as lockdowns are increasing across states, hurting revenues. Rising Covid 19 cases are forcing shutdown of economic activity.

Bond markets will continue to play for yields and there could be a flattening bias with longer end yields coming off given the steepness of the yield curve. Risk is that the steepness could signify that supply pressure would rise and inflation could stay above RBI target given higher food, fuel and labour costs.

The new benchmark 10-year bond, the 5.79% 2030 bond, yield came down by 9 bps to 5.76% on a weekly basis. Old benchmark 6.45% 2029, yield declined by 10 bps to 5.86%. New 5-year benchmark 5.22% 2025 yield decreased by 23 bps to 4.84%. The old benchmark 5-year bond, the 6.18% 2024 bond, yield came down by 20 bps to 4.74% while 7.17% 2028 bond yield decreased by 15 bps to 5.80%. The 6.68% 2031 yield level fell by 12 bps to 6.12% on a weekly basis. Long term paper 7.16% 2050 yield came down by 8 bps to 6.43%.

One-year OIS yield remained unchanged at 3.64% while the five-year OIS yield decreased by 1 bps to 4.16% 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 3026 billion as of 10th July 2020. Liquidity was in a surplus of Rs 3534 billion as of 03rd July 2020.

USD Weakens on Fed No Limit to Printing Policy

Currency Market Snapshot For The Week

• INR depreciated by 0.75% against the USD last week and depreciated by 1.18% against the euro.
• USD fell by 0.52% on a week on week basis and is at a level of 96.67.
• The British pound appreciated by 1.17% against the USD
• Euro appreciated by 0.49% 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 3 bps and is at negative 0.47%, the French 10-year bond yield fell by 2 bps.
• Italy's 10-year benchmark yield fell by 3 bps to 1.29%.
• US benchmark Junk bond yields fell by 7 bps to 6.49%

INR ended the week lower against USD last week amid persisting worries over the rising count of COVID-19 cases along with RBI reluctance for a stronger INR. Rising COVI19 cases in different parts of the country have led state governments to implement lockdowns again, which cast a shadow over expectation of any relatively quick rebound in the economic activity. INR depreciated by 0.75% against the USD last week and depreciated by 1.18% against the euro.

Market participants continue to be wary of the RBI action to curb any sharp rise in the INR given RBI's USD-buying interventions in the spot market as well as through the forwards segment, which signaled that the RBI is reluctant for a stronger INR.

In the ongoing financial year that began in April, RBI has added nearly USD 35.5 billion to its foreign exchange reserves so far, taking the total to USD 513.25 billion as of 3^rd July. The net increase in reserves roughly amounts to over Rs 2.2 trillion, which suggests that the currency market operations have substantially added to the liquidity surplus in the banking system.

USD ended the week lower as market participants hoped for more fiscal stimulus from governments across the globe, which may increase dollar liquidity in markets and lift the appetite for riskier assets. USD Index (DXY), which tracks the movement of the USD against six major currencies, fell by 0.52% on a week on week basis and is at a level of 96.67.

Comments by US Federal Reserve Vice-Chairman Richard Clarida in an interview on Tuesday led to the hope of another stimulus plan by the Fed to bolster economic growth in the US. Clarida said there was "no limit" on the extent of bond purchase by the US central bank, and that the Fed could ease monetary policy further with forward guidance.

However, USD traded higher in the latter part of the week largely due to its safe-haven status as coronavirus cases continued to surge in the United States and unemployment data pointed to a slow recovery in the labor market. Some states, including Florida, Texas, and California, reported a record number of new cases on Thursday.

The number of U.S. citizens filing for jobless benefits dropped more than expected last week, but the figure remained above one million for the 16th straight week.

Weekly Global Bond Market Analysis
US 10-year benchmark bond yield fell by 5 bps last week and is at 0.62%, as concerns about the impact of rising U.S. coronavirus cases supported inflows into government bonds. Last week, U.S. Treasury auctions also demonstrated the strong demand for safe assets as the treasury auction of USD 29 billion of 10-year notes fetched its lowest yield in the auctions history.>Eurozone bond yields were largely down last week as investors awaited fresh developments on a European Union recovery fund that aims to help the regions economy rebound from the coronavirus pandemic. German 10-year bond yield fell by 3 bps and is at negative 0.47%, France 10-year bond yields fell by 2 bps and is at negative 0.14%. Italys 10-year benchmark yield fell by 3 bps.>Expectations are high that the euro 750 billion (USD 851.70 billion) fund will be approved at an EU summit late next week which is intended to offer mostly grants to the countries that are worst hit by the coronavirus in the region.>US benchmark Junk bond yield fell by 7 bps and is at 6.49%, Euro benchmark Junk bond yields fell by 7 bps to 4.42%.