Inflation, Fiscal Mess, Operation Twist, Auction Devolvement add to Market Fears

Inflation, Fiscal Mess, Operation Twist, Auction Devolvement add to Market Fears

Bond Market Snapshot For The Week

• RBI devolved Rs 180 billion of 5.77% 2020 bond in last weeks Rs 320 billion bond auction
• RBI conducted special OMO (Operation Twist) of Rs 200 billion on 27th August
• Union Government asked State Governments to borrow USD 32 billion from the market in order to meet tax shortfall
• 5.79% 20230 closed at 6.10%, down by 4 bps on a weekly basis while 5.77% 2030 yield rose by 5 bps to 6.14%
• 5-year OIS yield rose by 14 bps to 4.63% on a weekly basis
• CCIL SDL Index closed at 6.55%, up by 16 bps on a weekly basis
• Liquidity continues to be in surplus at Rs 3.73 trillion

RBI August 2020 policy minutes suggest hawkishness over inflation and possibility of no more rate cuts going forward. Central and state government finances are in a huge fiscal mess and borrowings are set to increase from already high levels. Normally inflation plus heavy bond supply will push up yields sharply to levels where the market is comfortable in absorbing the supply. However, RBI is sending yield signals by conducting operation twist, which is simultaneous sale of bonds at the short end of the curve and purchase of bonds at the long end of the curve and devolving the full amount of bonds of the 5.77% 2030 offered for Rs 180 billion in the auction last week.

Primary dealers are now sitting on Rs 180 billion of inventory with bond supply looking to trend higher. If RBI does not follow up the devolvement with aggressive steps such as very large size of operation twist or even outright bond purchases, the inventory will be dumped in the market leading to sharp rise in yields.

On the other hand, highly aggressive steps by the RBI to protect bond yields can lead to yields coming off sharply though the floor will be set at closer to 5.90% to 6% levels as incremental supply and inflation fears will weigh on the market.

Union Government allowed State Governments to borrow USD 32 billion from the market in order to compensate tax shortfall due to economic lockdown. In addition, RBI can lend to States at a preferential rate up to Rs 970 billion with the support of the Union Government. Going ahead, SDL spreads may experience an uptrend as a consequence to extra market borrowing.

During the week, the 5.77% 2030 yield rose by 5 bps to 6.14%. On the other hand, 5.79% 2030 bond yield came down by 5 bps to 6.09% on a weekly basis. 6.45% 2029 bond yield increased by 7 bps to 6.27%. 5-year benchmark 5.22% 2025 yield increased by 12 bps to 5.53%. 6.19% 2034 yield level moved up by 4 bps to 6.49%. Long term paper 7.16% 2050 yield level rose by 3 bps to 6.75% on a weekly basis.

On a weekly basis, the spread of 10-year bond over 3-year bond (6.84% 2022) declined to 162 bps from 184 bps. The spread of 10-year bond over 5-year bond (5.22% 2025) came down to 57 bps from 73 bps last week. However, 15-year benchmark over 10-year benchmark spread rose to 38 bps from 24 bps. In the same line, 30-year benchmark over 10-year benchmark spread increased to 62 bps from 44 bps last week.

In the weekly SDL auction, the average 10 years SDL cut-off yield stood at 6.65% as compared to 6.50% during last week. Spread over benchmark 10-year yield remained flat at 49 bps from 51 bps of last week auction.

One-year OIS yield moved up by 5 bps to 3.87% while the five-year OIS yield rose by 14 bps to 4.63% 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 3732 billion as of 28th Aug 2020. Liquidity was in a surplus of Rs 3755 billion as of 21st Aug 2020.

INR Gains on stronger FII inflows

Currency Market Snapshot For The Week

• INR appreciated by 1.98% against the USD last week and by 1.19% against the euro.
• USD declined by 0.94% on a week on week basis and is at a level of 92.37.
• The British pound appreciated by 2% against the USD
• Euro appreciated by 0.90% against the USD.

Global Bond Market Snapshot For The Week

• US 10-year benchmark bond yield rose by 8 bps and closed at 0.72% last week.
• German 10-year bond yield rose by 10 bps and is at negative 0.41%.
• Italys 10-year benchmark yield rose by 4 bps to 1.04%.
• US benchmark Junk bond yields down by 26 bps to 5.37%

INR ended the week sharply higher at Rs 73.4 against USD on sustained foreign fund inflows particularly into Indian equity markets this month and on weakness in USD globally. In August, FIIs bought equities of USD 6.22 billion. Indias forex reserves continued to stay at record highs at USD 537 billion as on 21st August 2020.Risk appetite improved across the globe, reflecting substantial gain in emerging and other developed currencies against USD.

USD ended the week lower against major world currencies after the Federal Reserve Chairman, Jerome Powell, speaking at economic policy symposium Jackson Hole, indicated that US Fed will steadfastly seek to achieve a 2% inflation rate over time. USD Index (DXY), which tracks the movement of the USD against six major currencies, rose by 0.94% and is at a level of 92.37.

Longest serving Japanese Prime minister Shizo Abe resigned due to health concerns, USD/JPY was highly volatile last week in the range of 106.57-105.37.

Shrugging of Covid-19 surge in cases, GBP and Euro gained 2% and 0.9% against USD last week.

Data released by the U.S. on Friday showed US personal consumption expenditures rose 1.9% in July and personal income increased 0.4% while income posted decrease in May and June 2020.As per the second estimates, US Real GDP decreased at an annual rate of 31.7% in the Q2FY20, In July 2020 U.S. durable goods orders rose 11.2%, above estimates.

Weekly Global Bond Market Analysis
US 10-year benchmark bond yield rose by 8 bps last week and is at levels of 0.72% as Fed chairman announced that the Fed seek to achieve a 2% inflation and keeping unemployment rate lower to support the economy.US long bond rates rose while short end dipped, steepening the yield curve during week>Eurozone bond yields rose last week. German 10-year bond yields rose by 10 bps to negative 0.41%, reaching 2-month highs, France 10-year bond yields rose by 9 bps at negative 0.11%. Italys 10-year bond yield rose by 4 bps to a level of 1.04%.>US benchmark Junk bond yield fell by 26 bps and is at 5.37%, Euro benchmark Junk bond yields fell by 4 bps to 3.87%.