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 4645 billion as of 1st September 2017 from levels of Rs 3437 billion as of 25th August 2017. The surplus was Rs 4215 billion as of 18th August, Rs 4596 billion as of 11th August and Rs 5112 billion as of 1st August. Liquidity surplus has seen wide fluctuations over the last one month.
RBI has announced an OMO sales auction of Rs 100 billion to suck out longer term liquidity. RBI’s stated aim is to bring liquidity to neutral territory and will use tools of OMOs, MSS, CMB and Reverse Repo to bring down liquidity. RBI’s liquidity management has been hampered by government spending and by its own fx operations, where it has been a net buyer of fx, both in spot and forward markets.
Demonetization has added around Rs 2 trillion of liquidity into the system as seen by drop in currency in circulation from levels of Rs 17.4 trillion to Rs 15.4 trillion over the last one year. The rest of the liquidity is accounted for by government spending and RBI fx purchases. RBI will have a tough time in managing this liquidity and this will filter into bond market uncertainty on money market yields.
GDP growth for the 1st quarter of this fiscal year came in at 5.7%, well below RBI’s and government’s forecast of over 7% growth for the full fiscal year. If growth estimates are to be held, GDP growth would have to clock closer to 8% over the next three quarters, which looks highly unlikely. RBI might have to go in for aggressive rate cuts if growth rates have to improve.
Inflation expectations for August have risen on the back of rise in fuel prices and seasonal rise in prices of fruits and vegetables. RBI would have to manage its inflation target mandate with its need to keep economic growth on a steady path in its October 2017 policy review. Bond markets will also tussle with RBI’s confusion and will keep yields range bound till the October policy review.
US 10 year treasury yields fell to their lowest levels this year on the back of risk aversion on North Korea Jingoism, Hurricane Harvey that devastated Houston, worries of Trump’s ability to push through tax reforms and persistent low wage growth and inflation. US employer’s added 156,000 jobs in August against expectations of 180,000 jobs, unemployment rate edged up to 4% while wage growth was flat. US CPI inflation has been printing below Fed’s target of 2% over the last couple of months and this has concerned the Fed. Rate hike bets this year are inching down though one more 25bps rake hike is the most probable outcome for the Fed this year.
Government bond yields fell last week on the back of weak GDP growth numbers. The benchmark 10 year bond, the 6.79% 2027 bond saw yields close down by 5bps week on week at levels of 6.48%. The on the run bond, the 6.79% 2029 bond saw yields close down by 4bps to close at 6.81%. The long bond, the 7.06% 2046 bond saw yields close down by 3bps at levels of 7.11%. The new issue of 6.68% 2031 bond for Rs 90 billion saw huge demand with bids worth Rs 493 billion. This bond will see active trading and spreads with the 10 year bond will trend down.
The OIS market saw 5 year OIS yields falling by 4bps week on week to close at levels of 6.17%. The one year OIS yield fell by 4bps to close at 6.07%. OIS yields will fall on rate cut expectations and on fall in US treasury yields.
Corporate bond yields fell last week. 10 year benchmark AAA bond yields closed down by 7bps at 7.37% levels with spreads down by 1bps at 79bps levels. 3 year AAA spreads were flat at 52bps and 5 year spreads were down by 2bps at 52bps. Benchmark 3 year AAA corporate bond yields closed down by 1bps at 7.00% levels. 5 year benchmark AAA bond yields closed down by 4bps at 7.10%. Credit spreads are likely to come off on liquidity and rate cut expectations.