RBI lowering inflation expectations in its policy review last week will flatten yield curves as markets buy into long bonds on falling inflation risk premium in yields. CPI inflation for May is expected to come in below April’s print of 2.99%, which will lead to further bullish trades on long bonds. Market will also start to factor in GST effects on prices, which the RBI had ignored in its policy review.
GST implementation starting July is leading to inventory destocking through huge discounts. GST by itself is benign and rates are lower for most of the consumer goods. CPI inflation will reflect inventory destocking and lower tax rates over the next few months. CPI inflation can undershoot RBI revised inflation target of 2% to 3.5% for the 1st half and 3.5% to 4.5% for the 2nd half of this fiscal year.
Gsec yield curves have started to flatten. The 10 over 30 spreads came off by 8bps to 58bps levels with the benchmark 30 year gsec yield falling by 20bps last week and the benchmark 10 year gsec yield falling by 12bps. Markets will pull down this spread further on bullish long bond trades.
The market will also search for any off the curve yields and look to pull it down on expectations of curve alignment in a bullish market.
Government bond yields came off last week on the back of RBI policy. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close down 12bps week on week at levels of 6.50%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close down by 12bps at 6.63% levels while the on the run bonds, the 6.79% 2029 bond and the 7.06% 2046 bond saw yields drop by 14bps and 20bps respectively to close at levels of 6.66% and 7.08%. Gsec yields are likely to fall further on the back of RBI policy.
OIS market saw one year yield fall by 11bps and five year OIS yield fall by 22bps last week. One year OIS yield closed at 6.26% while five year OIS yield closed at 6.28%. OIS curve spreads fell by 11bps. The spread can invert on rate cut expectations.
10 year benchmark AAA bond yields closed lower by 21bps at 7.40% levels with spreads down by 9bps at 79bps levels against the new 10 year benchmark gsec, the 6.79% 2027 gsec. 3 year and 5 year AAA spreads were lower by 7bps and 2bps at 57bps and 52bps respectively. Benchmark 3 year AAA corporate bond yields closed lower by 19bps at 7.13% levels. 5 year benchmark AAA bond yields closed lower by 18bps at 7.23%. Credit spreads are likely to come off further on RBI policy.
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 4808 billion as of 9th June 2017. The surplus was Rs 5655 billion in the week previous to last. Liquidity fell on the back of rise in currency in circulation.