Bond Market is Testing RBI’s Resolve to Protect Bond Yields

Bond Market is Testing RBIs Resolve to Protect Bond Yields

Bond Market Snapshot For The Week

• Domestic inflation rose to 6.93% in July 20 from 6.23% in the previous month
• India IIP contracted by 16% on June 20
• The RBI Board approved the transfer of Rs 571.28 billion as surplus to the Central Government for the accounting year 2019-20
• 10-year benchmark yield closed at 5.97%, up by 8 bps on a weekly basis while the new 10-year paper yield rose by 11 bps to 5.95%
• 5-year OIS yield rose by 16 bps to 4.45% on a weekly basis
• CCIL SDL Index closed at 6.35%, up by 1 bps on a weekly basis
• Liquidity continues to be in surplus at Rs 2.5 trillion

RBI devolved around 20% of the new 10 year bond, the 5.77% 2030 bond, on to the primary dealers, indicating its unwillingness to chase the tail. The market was spooked by inflation for July printing at close to 7% levels and cut off yield for the 5.77% 2030 bond in the auction was 5.96%, almost 20bps higher than the yield at which the bond was first auctioned in end July.

RBI in its policy meet earlier this month chose to hold the policy rate status quo, as it did anticipate a rise in inflation. However, accommodative stance was maintained with room for more rate cuts, given its focus on pulling up economic growth from contraction levels. The bond market is swamped with supply given the high and intensive government borrowing and is worried about absorbing the supply at lower levels of yields, given high inflation.

The market will continue to show a yield risk aversion streak and auctions will see higher levels of bids in terms of yields. This will test RBIs resolve in keeping yields down for economic recovery.

RBI will have to step in to buy bonds through OMOs and carry out more operation twists to protect yields but given constant supply, a continued market risk aversion can make it difficult for the RBI to manage the yield curve.

In weekly India government bond auction, 5.77% 2030 witnessed the development of Rs 46.38 billion on primary dealers. In the auction of 5.77% GS 2030 bond cut-off yield stood at 5.9634%, more than that last traded yield of 5.95%.

Indias retail inflation increased to 6.93% in July 2020 from the revised rate of 6.23% in June 2020 driven by higher food prices that have breached the target inflation range set by RBI. The Consumer Food Price Index (CFPI) surged to 9.62% in the month of July from 8.72% in the previous month. The rise in the inflation rate has diminished further rate cut by RBI MPC. Core inflation was at around 5.5%.

Domestic industrial production contracted by 16.6% in June on a yearly basis as compared to a revised contraction of 34% in the previous month. Within sectoral outputs, manufacturing output contracted by 17.1% in June as compared to a contraction of 38.4% in May while mining output contracted by 19.8% in June as against a drop of 20.5% last month. In the same line, electricity generation contracted by 10% compared to a contraction of 14.9% in May.

The RBI Board approved the transfer of Rs 571.28 billion as surplus to the Central Government for the accounting year 2019-20 while deciding to maintain the Contingency Risk Buffer at 5.5%.

During the week, the new 10-year benchmark yield rose by 11 ps to 5.95%. The benchmark 10-year bond, the 5.79% 2030 bond yield rose by 8 bps to 5.97% on a weekly basis. 6.45% 2029 bond yield increased by 3 bps to 6.03%. 5-year benchmark 5.22% 2025 yield increased by 12 bps to 5.23%. The old benchmark 5-year bond, the 6.18% 2024 bond, yield rose by 10 bps to 5.1% while 7.17% 2028 bond yield increased by 4 bps to 5.97%. 6.19% 2034 yield level moved up by 4 bps 6.28% on a weekly basis. Long term paper 7.16% 2050 yield rose by 1 bps to 6.51% on a weekly basis.

One-year OIS yield increased by 7 bps to 3.84% while the five-year OIS yield rose by 16 bps to 4.45% 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 2478 billion as of 14th Aug 2020. Liquidity was in a surplus of Rs 2860 billion as of 07th Aug 2020.

USD Claws Back Some Losses on Unemployment Rate Fall

Currency Market Snapshot For The Week

• INR appreciated by 0.04% against the USD last week and appreciated by 0.24% against the euro.
• USD fell by 0.36% on a week on week basis and is at a level of 93.10.
• The British pound appreciated by 0.26% against the USD
• Euro appreciated by 0.47% against the USD.

Global Bond Market Snapshot For The Week

• US 10-year benchmark bond yield rose by 15 bps and closed at 0.71% last week.
• German 10-year bond yield rose by 9 bps and is at negative 0.42%.
• Italys 10-year benchmark yield rose by 6 bps to 1.05%.
• US benchmark Junk bond yields rose by 21 bps to 5.57%

INR ended the week marginally higher against USD despite volatile trading sessions during the week, the gains were largely in anticipation of foreign fund inflows as many Indian companies are in the process of raising funds from foreign investors through the qualified institutional placement of shares, initial public offers, and other means. However, RBI intervention in the forex market restricted any sharp appreciation of INR. INR appreciated by 0.04% against the USD last week and appreciated by 0.24% against the euro.

On the data front, Indias retail inflation stood at 6.93% for the month of July as against 6.23% in the month-ago period. The consumer price index (CPI)-based inflation rate for June has been revised from 6.09% to 6.23%.

USD traded lower last week amid growing uncertainty over the US stimulus package due to the stalemate between the Democrats and the Republicans in Congress. However, Trump signed a series of executive orders to extend unemployment benefits, the orders would provide payments of USD 400 per week to the unemployed in the US, lower than the USD 600 per week passed amid the COVID-19 crisis.

USD Index (DXY), which tracks the movement of the USD against six major currencies, fell by 0.36% and is at a level of 93.10.

However, an escalation in diplomatic tensions between the US-China and disappointing Chinese data released on Friday dampened the risk sentiment providing support to USD. Chinese data indicated a continuous but slower recovery in industrial production, as well as a bigger-than-expected drop in retail sales. In July, Chinese industrial production rose 4.8% year-on-year but missed the expectation of a 5.1% rise. Meanwhile, retail sales fell 1.1% in the same month, against the expectation of 0.1%. The unemployment rate remained unchanged at 5.7%.

An escalation in diplomatic tensions between the US and China is weighing on the global risk sentiment. US President Donald Trump earlier banned operations of Chinese technology companies ByteDance and Tencent, citing that their applications Tiktok and WeChat, respectively, are a threat to national and economic security. China, in retaliation to the US move to impose sanctions on 11 senior officials from China and Hong Kong, announced sanctions on 11 US officials.

The U.K. economy shrank by a record of 20.4% between April and June, the largest contraction reported by any major economy to date. This means the U.K.s economy, the worlds sixth-biggest, has entered a recession, its first since the financial crisis, as the previous quarter had also seen a gross domestic production contraction.

Weekly Global Bond Market Analysis

US 10-year benchmark bond yields rose by 15 bps last week and are at levels of 0.71% after the release of stronger-than-expected economic numbers which added to the signs that the U.S. recovery continued to make steady progress.

Retail sales in July rose by 1.2%. Second-quarter productivity jumped 7.3%, while second-quarter unit labor costs surged by 12.2%. Industrial production rose 3% in July for the third straight monthly gain after sharp declines in March and April.

Eurozone bond yields rose last week as German 10-year bond yields rose by 9 bps to negative 0.42%, France 10-year bond yields rose by 8 bps at negative 0.13%. Italys 10-year bond yield rose by 6 bps to a level of 1.05%.

US benchmark Junk bond yield rose by 21 bps and is at 5.57%, Euro benchmark Junk bond yields fell by 17 bps to 3.87%.