Bond market is jittery and this is showing in trading volumes and appetite for government bond auctions. Trading volumes have dropped by more than 50% over the last one month and RBI has been devolving bonds on to the underwriters in the bond auctions due to bids carrying a long tail (Long tail is a term used when bids for auction bonds are at yields that are way higher than weighted average bid yields).
The reasons for the bond market nervousness include a depreciating INR that is down to over 1 year lows against the USD, rising oil prices that are trading at three year highs, falling system liquidity that is down from over Rs 2 trillion to levels of below Rs 500 billion, hawkish RBI April policy minutes that saw two members favouring rate hikes, high levels of SDL supply that is equal to government bond supply and banks looking to sell bonds as they are holding bonds equivalent to 30% of NDTL against SLR of 19.5%. Bank deposit growth too has slowed down to levels of below 5% since December 2017 and incremental appetite for banks to buy or hold bonds is low.
Fed rate hikes and rise in US treasury yields too have hurt market sentiments.
RBI has announced an OMO purchase auction of Rs 100 billion, scheduled for the 17th of May. Given that RBI has intervened in the currency market to sell USD to stem INR fall and that currency in circulation has increased by over Rs 700 billion over the last one month, liquidity has been draining out of the system. RBI needs to buy bonds more aggressively to add liquidity and also to calm the bond market.
Data points have been more positive than negative for bonds. Government saw GST collections top Rs 1 trillion in April 2018, which calms fears of government finances slipping. CPI inflation for March came in at 5 months lows and IIP data shows growth, which is positive for tax collections. US non farm payrolls for April came in below expectations, at 164,000 against 192,000 while unemployment rate fell to 18 year lows of 3.9%. Wage growth, however, was muted leading to lower inflation expectations. Fed has guided for a gradual pace of rate hikes, which is positive for markets.
Government bond yields will tend to stay ranged at levels of 7.65% to 7.80% over the next few weeks while OIS and corporate bond yields will stay steady at current levels. Money market securities yields will tend to stay at higher levels till RBI infuses enough liquidity through bond purchases.
The benchmark 10 year bond, the 7.17% 2028 bond, saw yields fell by 4 bps to close at 7.73%. The benchmark 5 year bond, the 7.37% 2023 bond saw yields fell by 2 bps to close at 7.76% and the 6.68% 2031 bond saw yields fell by 3 bps at 7.97%. The long bond, the 7.06% 2046 bond saw yields remain flat at levels of 7.73%.
The OIS market saw 5 year OIS yields closing 2 bps up week on week at levels of 7.06%. The one year OIS yield closed up by 1 bps at 6.61%. OIS yields will stay ranged on uncertain markets.
Corporate bonds saw 5 year AAA corporate bond yields fall by 7 bps at levels of 8.38% and 10 year AAA corporate bond yields fall by 2 bps at 8.43%. 5 year AAA spreads fell by 5 bps at 62bps and 10 year AAA spreads rose by 2 bps at 70 bps.
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 472 billion as of 4th May 2018. Liquidity was in surplus of Rs 120 billion as of 27th April.