The bond market is giving good levels for making money over the next 2 months. Bond yields have backed up sharply over a shot spam of time and risk – return is in favour of long rather than short positions. However, given the current weak market sentiment, long positions could see high mark to market volatility and a graded approach is required to build positions. Traders and investors should also exhibit patience over nervousness once positions are starting to build.
Spreads are clearly attractive as yield spreads over the overnight funding rate are high. Bond yields are unnecessarily factoring in multiple rate hikes and tight liquidity conditions going ahead. Current macro economic conditions do not warrant a rate hike, leave alone multiple rate hikes and liquidity conditions will stay extremely easy for long periods of time. Bond yields can come off sharply from highs over the next 2 months, once market sentiments stabilize.
RBI is unlikely to raise rates in its policy meet on the 6th and 7th of February given that inflation expectations are not overshooting its target of 4% +/- 2%. Government has projected GDP growth of 7.5% for fiscal 2018-19 with GDP deflator of 4%, indicating that inflation is unlikely to trend much higher in the next fiscal year. Government fiscal deficit target of 3.3% of GDP for fiscal 2018-19 is also not inflationary in nature as expenditure growth is curbed at 10.1%. India’s fx reserves are at all time highs, RBI has a strong forward position in USD, which it can use to curb any INR volatility caused by global risk aversion.
Bond markets have reacted to sharply rising UST yields with 10 year UST closing last week at 4 year highs of 2.84% on the back of strong US jobs data for January. Read our Weekly Currency Note for details of US January job numbers. However, despite rise in UST yields, the USD has weakened considerably against the Euro and Yen, indicating that there is no strong flight of capital from emerging markets to USD assets.
Bond market has also taken a net gsec borrowing of Rs 4.62 trillion for fiscal 2018-19 negatively. However, the borrowing includes buy back funding of Rs 710 billion, which can be done without disrupting the markets.
Liquidity will stay easy in the system as the government front loads its spending starting April 2018. RBI outstanding forward USD position of over USD 30 billion is latent liquidity of over Rs 2 trillion. 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 surplus of Rs 1230 billion as of 2nd February 2018. The surplus was Rs 808 billion as of 26th January.
The old 10 year benchmark government bond, the 6.79% 2027 bond, saw yields rise by 25bps week on week to close at levels of 7.75% while the new benchmark 10 year bond, 7.17% 2028 bond, saw yields rise by 26bps to close at 7.56%. The on the run bond, the 6.79% 2029 bond saw yields close 21bps up at 7.69% levels and the 6.68% 2031 bond saw yields close up by 26bps at 7.84%. The long bond, the 7.06% 2046 bond saw yields close up by 6bps at levels of 7.73%. Gsec yield spreads of over 150bps over the Repo offer strong carry as well as discouraging shorting given the negative carry on shorts.
The OIS market saw 5 year OIS yields closing 19bps higher week on week at levels of 6.89%. The one year OIS yield closed up by 13bps at 6.55%. OIS yield curve is trading below the gsec yield curve indicating that swap market is unwilling to take too much negative carry on shorts.
Corporate bonds saw 5 year AAA corporate bond yields close up by 12bps at levels of 7.92% and 10 year AAA corporate bond yields close up by 20bps at 8.16%. 5 year AAA spreads fell by 7bps at 35bps and 10 year AAA spreads fell by 8bps at 44 bps. Credit spreads have fallen sharply as corporate bond yields have risen faster than government bond yields indicating that government bond sell off is overdone.