When New and Old 10yr Spreads Flatten, Bull Widening is the Next Move

When New and Old 10yr Spreads Flatten, Bull Widening is the Next Move

Bond Market Snapshot For The Week

• Consumer inflation rate grows by 6.09% in June 2020
• India registered a trade surplus of USD 790 million in June driven by a fall in imports due to Corona Pandemic
• Domestic industrial activity improved in May 20 as compared to previous month
• New 10 year benchmark yield closed at 5.80%, up by 4 bps on a weekly basis
• 5-year OIS yield rose by 7 bps to 4.23% on a weekly basis
• CCIL SDL Index closed at 6.36%, down by 6 bps on a weekly basis
• Liquidity continues to be in surplus at Rs 2.70 trillion

The spread differential between the new 10 year bond, the 5.79% 2030 bond and the old 10 year bond the 6.45% 2029 bond is at just 9bps. The spread has fallen from over 20bps since the issuance of the new bond. The sharp fall in spread indicates that the market is bullish and is willing to compress the spread for extra yield.

The spread cannot stay flat as the market has to find the next move and given that the market is still bullish on bonds despite supply and inflation, the move can be in the form of the yield on the 5.79% 2030 bond moving down. This will then cause a spread widening with the 6.45% 2029 bond, as the yield will turn sticky on this bond given that markets will tend to shun this bond for the new 10 year.

At this point of time, high supply in the new 10 year bond has caused the yield to stagnate even as spreads have come off across the longer end of the curve. The spreads of the 6.68% 2031 bond and the 7.16% 2060 bond have fallen sharply with the new 10 year bond. SDL spreads too have come off, indicating that the market is embracing any spread available.

Indias retail inflation, CPI, grew 6.09% in June 20 while Consumer Food Price Index (CFPI) moderated to 7.87% in the month of June as the supply smoothened due to some relaxation in the nationwide lockdown.

India posted a trade surplus in June for the first time in more than 18 years as imports plunged due to the Corona pandemic that impacted domestic demand drastically. In June 20, merchandise exports contracted by 12.4%, while imports came down by 47.6%, leading to a trade surplus of $790 million.

India's industrial production contracted by 34.7% in May 20, improved from 57.6% contraction in the previous month. This indicates that industrial activity picked up in May as the nationwide lockdown was relaxed.

The new benchmark 10-year bond, the 5.79% 2030 bond, yield rose by 4 bps to 5.80% on a weekly basis. 6.45% 2029, yield increased by 3 bps to 5.89%. New 5-year benchmark 5.22% 2025 yield increased by 4 bps to 4.88%. The old benchmark 5-year bond, the 6.18% 2024 bond, yield rose by 8 bps to 4.82% while 7.17% 2028 bond yield increased by 1 bps to 5.81%. On the other hand, 6.68% 2031 yield level lost 2 bps to 6.1% on a weekly basis. 6.19% 2034 bond yield closed at 6.15% on 17th July. Long term paper 7.16% 2050 yield gained by 5 bps to 6.48%.

One-year OIS yield rose by 7 bps to 3.71% while the five-year OIS yield increased by 7 bps to 4.23% 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 2708 billion as of 17th July 2020. Liquidity was in a surplus of Rs 3026 billion as of 10th July 2020.

INR Gains Despite Jittery Market Sentiments

Currency Market Snapshot For The Week

• INR appreciated by 0.24% against the USD last week and depreciated by 0.71% against the euro.
• USD fell by 0.75% on a week on week basis and is at a level of 95.94.
• The British pound depreciated by 0.48% against the USD
• Euro appreciated by 1.11% against the USD.

Global Bond Market Snapshot For The Week

• US 10-year benchmark bond yields remained flat at 0.62% last week.
• German 10-year bond yield rose by 2 bps and is at a negative 0.45%.
• Italy's 10-year benchmark yield fell by 6 bps to 1.23%.
• US benchmark Junk bond yields fell by 38 bps to 6.11%

INR ended the week higher against the USD despite rising global uncertainties, as the rise in domestic benchmark indices supported the INR. Foreign portfolio investors have provided additional support to the INR as they subscribed to the YES Bank's follow-on public offer and Bharat Bond exchange-traded fund.

However, rising tension between the US and China, and possible disruptions in economic recovery amid rising cases of COVID-19 continue to weigh on INR. INR appreciated by 0.24% against the USD last week and depreciated by 0.71% against the euro.

The expectations of another fiscal stimulus in the US and progress on the European Union's recovery fund to bolster economic growth has supported INR and other EM currencies.

USD traded lower last week as daily coronavirus cases climbed to a record high, above 72,000. Additionally, the gains in euro and rising conflict with China put pressure on USD. With daily cases more than doubling since late June, many states have been forced to pause or roll back reopening measures. USD Index (DXY), which tracks the movement of the USD against six major currencies, fell by 0.75% on a week on week basis and is at a level of 95.94.

On Wednesday, US Secretary of State Mike Pompeo said Washington will impose visa restrictions on employees of the Chinese technology giant Huawei Technologies Co Ltd and other companies, citing violation of human rights. Further, the US was considering a travel ban on members of the China Communist Party and their families. This comes after President Donald Trump signed a bipartisan bill on Wednesday which imposed sanctions on China for its security legislation in Hong Kong. China, in response, said it will impose retaliatory sanctions on individuals and entities from the US.

Some of the emergency coronavirus relief measures in the US are set to expire by the end of this month. In an interview earlier, US Federal Reserve Vice Chairman Richard Clarida had said there is "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.

Euro appreciated by 1.11% against USD last week on the expectation that the European Union nations would agree on the euro 750 billion recovery fund to bail out worst-hit nations in the common bloc by the pandemic. European Council President Charles Michel offered a proposal to make the fund more acceptable by focusing on funding elements around climate change, the rule of law, and Brexit.

Weekly Global Bond Market Analysis
US 10-year benchmark bond yields remained flat at 0.62% last week. The bond market came under slight pressure amid growing worries about the risk of inflation, even though the economys recovery faces challenges in face of the coronavirus pandemic.

U.S. economic data also heightened inflation concerns. The University of Michigans consumer sentiment gauge for July fell to 73.2 from 78.1 last month, but five-year inflation expectations rose to 2.7% from 2.5%.

Eurozone bond yields were largely mixed last week after the ECB, as expected, made no changes to interest rates or its asset-buying program, after having expanded the size of its pandemic emergency purchase program, or PEPP, in June.

German Chancellor Angela Merkel said that there remained significant differences between European leaders over a fiscal bailout package and a budget for the European Union, amid hopes by market participants that the EU would employ more stimulus measures to support their coronavirus-battered economies.

German 10-year bond yield rose by 2 bps and is at negative 0.45%, France 10-year bond yields remained flat at negative 0.14%. Italys 10-year benchmark yield fell by 6 bps.

US benchmark Junk bond yield fell by 38 bps and is at 6.11%, Euro benchmark Junk bond yields fell by 8 bps to 4.34%.