Bond prices tanked again last week, taking 10 year benchmark government bond yields to two year high levels of over 7.75%. Bond yields have been on a sustained rise since October 2017, with yields rising by over 100bps. Bond yields rose to levels of 7.78% last week before paring losses to close at 7.68%. The reason for rise in bond yields was minutes of RBI February MPC (Monetary Policy Committee) meet that was seen as hawkish by the market. Read our report on
Bond market has lost confidence with the sustained rise in yields. Banks are staying out of the market as deep mark to market losses have hurt their risk taking ability. PSU banks are also running SLR portfolios that are well above the statutory limit of 19.5% at levels of around 30%. Banks do not have space to buy bonds and that is leading to traders not being able to down sell positions to a captive market segment. This is giving rise to positions on benchmark bonds being rotated within the market with every trade resulting in higher levels of yields.
Insurers and provident funds, two large captive market segments are also shunning the market in favour of subscribing to SDL’s. Weekly SDL auctions over Rs 130 billion is providing the supply for investors as cut off yields are over 8.10%, which is seen as attractive.
FII’s are quiet though not active sellers despite a weakening INR that is down over 1.5% against the USD over the last one month. FII limits are almost fully utilized and with rising US treasury yields, risk appetite is low for INR Bonds.
Bond market requires a stabilizing factor to shore up its confidence. However there does not seem to be any stabilizing factor on the horizon. The cloud over PSU Banks is casting a long shadow on the INR that fell below Rs 65 to the USD, which is seen as a psychological support level by the market. The INR strengthened in the last day of the trading week to close above Rs 64.73, on the back of RBI intervention. Markets are worried that FII’s could sell INR Bonds on the back of a falling currency.
RBI has largely stayed away from either moral suasion by talking to markets or direct intervention to prevent bond yields from rising too high. Bond markets will stay nervous and that will increase volatility until it gets back confidence, which may take a while.
The old 10 year benchmark government bond, the 6.79% 2027 bond, saw yields rise by 11bps week on week to close at levels of 7.85% while the new benchmark 10 year bond, the 7.17% 2028 bond, saw yields rise by 9bps to close at 7.68%. The on the run bond, the 6.79% 2029 bond saw yields close 14bps up at 7.83% levels and the 6.68% 2031 bond saw yields close up by 11bps at 7.94%. The long bond, the 7.06% 2046 bond saw yields close up 12bps at levels of 8.02%. Bond yields will swing violently on thin volumes in a nervous market sentiment environment. .
The OIS market saw 5 year OIS yields closing 10bps higher week on week at levels of 6.93%. The one year OIS yield closed up by 7bps at 6.56%. OIS yields will rise further on the back of rise in US treasury yields and rise in government bond yields.
Corporate bonds saw 5 year AAA corporate bond yields close up by 26bps at levels of 8.10% and 10 year AAA corporate bond yields close up by 13bps at 8.29%. 5 year AAA spreads rose by 10bps at 43bps and 10 year AAA spreads rose by 5bps at 47 bps. Credit spreads could trend up in the short term on news of EPFO reducing corporate bond purchases to 20% of incremental flows from 35% to 45% levels due to lack of availability of corporate paper. Expected liquidity tightness in March on advance tax outflows will also hurt spreads. However spreads will fall towards end of March on the back of easing liquidity expectations in April.
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 601 billion as of 23rd February 2018. The surplus was Rs 819 billion as of 16th February. Rise in government cash balances and rise in currency in circulation brought down liquidity, which could stay down on advance tax outflows and year end demand for funds in March.