Government bonds went on turbo drive last week, as plunging oil prices, falling global bond yields and RBI OMO announcements placed the market on a bull orbit. The decision by the GST council to slash rates on more items will also help yields trend down, as inflation expectations come off sharply.
Advance tax outflows drove down system liquidity and the rise in advance tax will ease some fears on government fiscal deficit.
Credit spreads, on the other hand, rose as markets are still wary of risk aversion on credit markets and on tight liquidity conditions. Spreads will recover on fears of too sharp fall in government bond yields leading to some bottom fishing on credit spreads.
RBI will buy a total of Rs 2360 billion of bonds in this fiscal year, a huge amount by any standards and the highest on record. Government bond net supply has more than halved on the back of RBI bond purchases. The question is, what about next year?, as the markets cannot get used to RBI buying even as fresh supply kicks in through a new borrowing program. Hence the reluctance of spreads to come off.
The 10-year benchmark government bond, the 7.17% 2028 bond, saw yields close 13 bps down at 7.28% on weekly basis. The benchmark 5-year bond, the 7.37% 2023 bond saw yields close 16 bps down at 7.14% and the 6.68% 2031 bond saw yields close 7 bps down at 7.49%. The long bond, the 7.06% 2046 bond yields close 12 bps down at 7.54% on weekly basis.
OIS market saw one year yield close down by 11 bps and five year OIS yield close down by 15 bps last week. One year OIS yield closed at 6.56% while five year OIS yield closed at 6.60%. OIS yield curve will stay flat given lack of rate hike expectations.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facility (MSF or Marginal Standing Facility) and MSS/CMB bond issuance was in deficit of Rs 1686 billion as of 21st December 2018. Liquidity was in a deficit of Rs 526 billion as of 14th December 2018. Liquidity will stay in deficit on advance tax outflows this month.
Credit Spreads Continue to Rise
Credit spreads continued to rise as government bond yields fell sharply.Credit sspreads stayed at elevated levels, as risk aversion continued given political risk and worries of slowing economy. Good credits at higher spreads do provide protection against interest rate movements and can be bought into.
· As on 21st December, FII debt utilisation status stood at 63.22% of total limits, 46 bps higher against the previous week. FII investment position was at Rs 4108 billion in INR debt. FII investment position stands at Rs 2098 billion in gilt securities that also includes investment in Interest Rate Futures and at Rs 2010 billion in corporate bonds.
· For the week ended 21st December, credit spreads increased. Three-year AAA corporate bonds were trading at levels of 8.65%, spreads were 6 bps higher at 147 bps against the previous week.
· Five-year AAA corporate bonds were trading at levels of 8.65%. Spreads were 9 bps higher at 138 bps.
· Ten-year AAA corporate bonds were trading at levels of 8.68% with spreads 10 bps higher at 117 bps.
· Three months and twelve months PSU bank CD yields were trading at 6.98% and 8.10% levels at spreads of 38 bps and 117 bps respectively against T-bill yields.
· Three months’ maturity Manufacturing and NBFC sector CPs were trading at 7.15% and 7.42% levels respectively. One-year maturity Manufacturing and NBFC sector CPs were trading at 8.57% and 8.80% levels respectively.
Weekly G-sec Curve Spread Analysis
· The yield curve steepened at the long end as 10-year G-sec yields fell by 13 bps while other long end bonds (6.68% 2031 & 7.06% 2046) yields fell by 7-12 bps. Bond yields fell sharply after RBI OMO announcement and correction in crude oil prices.
· RBI will conduct two OMO purchases of Rs 150 billion each in December, scaling up its total liquidity injection to Rs 500 billion for December, it had earlier planned to purchase Rs 400 billion worth of bonds in December, and it will also buy G-secs worth Rs 500 billion in January 2019.
· Off the run bond spreads with the 10-year G-sec were mixed last week.
· On the 18th December 2018 auction, the spread between SDLs with 10-year G-sec came in at 84 bps. On 11th December 2018 auction, the spread between SDLs with 10-year G-sec was at 83 bps.
