Bond market participants will never forget the June-September 2013 period when Fed led a crash in bond prices and the value of the INR. Bond yields rose by 150 bps -350 bps across the curve even as the INR fell to record lows. Fed had just started talking about tapering asset purchases, which led to the crash in markets in India. However at that point of time, India was running a CAD of 4.8% of GDP, fiscal deficit of 4.9% of GDP and inflation was running at over 10% levels. Forex reserves were 25% lower than what it is today. FII’s sold risk assets including emerging market currency and debt leading to the sharp negative reaction in Indian markets.
The Fed once again induced volatility in bonds and INR by guiding for rate hikes and reduction of its balance sheet. The INR fell to 6 months lows while 10 year gsec yields rose by 10bps. The INR and bond yields were also pressured by talks of fiscal stimulus by the government and higher CPI inflation print that lowered expectations of rate cuts by the RBI in its October policy review.
However, this time around, Fed’s guidance is more positive than negative for India as macros are extremely comfortable. CAD is at 2.4% of GDP as of 1st quarter of fiscal 2017-18. Fiscal deficit is targeted at 3.2% of GDP for this fiscal, inflation is at below 4% levels and fx reserves are at all time highs of USD 402 billion and technically at USD 428 billion with RBI carrying USD 26 billion of outstanding forwards.
Banking system is flushed with liquidity from demonetization, government spending and RBI fx purchases. Hence any volatility in the INR and bond prices will be temporary and will provide buying opportunity on falls but bond market nervousness will continue until the policy review on the 3rd and 4th of October.
Government bond yields rose last week on Fed and government fiscal stimulus plan. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close up by 7bps week on week at levels of 6.66%. The on the run bonds, the 6.79% 2029 bond and the 6.68% 2031 bond saw yields close up by 8bps and 12bps respectively to close at 6.95% and 6.84%. The long bond, the 7.06% 2046 bond saw yields close up by 4bps at levels of 7.15%. Gsec yields will stay pressured until RBI policy review next week.
The OIS market saw 5 year OIS yields closing 3bps higher week on week at levels of 6.28%. The one year OIS yield closed flat at 6.15%. OIS yields will stay ranged until policy next week.
Corporate bonds saw 3, 5 and 10 year AAA corporate bond yields rising by 12bps, 17bps and 11bps respectively. Credit spreads rose by 7bps, 5bps and 4bps respectively. RBI has increased FII limits for corporate bonds by Rs 440 billion by taking out masala bonds from the total limits and FII’s should buy into higher spreads once markets stabilize.
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 Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 2395 billion as of 22nd September 2017. The surplus was Rs 3598 billion as of 15th September. Advance tax outflows led to fall in system liquidity.