RBI April policy minutes released this week saw all the six members sounding out warning on inflation with one member calling for a preemptive rate hike of 25bps. The markets have started to take out all chances of rate cuts and have started to factor in a very small probability of rate hikes this year. RBI had maintained policy rates status quo with a neutral bias in its policy in April with all members unanimously voting to keep policy rates unchanged.
RBI is in a liquidity sucking out mode, auctioning Rs 250 billion of Tbills under MSS last week and is scheduled to auction Rs 750 billion of Tbills over the next 3 weeks. RBI has also announced an auction of 15 days Cash Management Bills (CMB) for Rs 200 billion this week. Government spending and RBI fx purchases to stem INR appreciation are flooding the system with liquidity, which is already flushed with demonetization funds.
Bond markets will be seeing heavy supply of bonds from MSS, CMB, Government Bond and SDL auctions and given that a large percentage of these auctions are in the less than one year to ten year segment of the curve, yields will be pressured in this segment. Markets will tend to look at bonds at the longer end of the curve, 15 to 30 years, for shelter as spreads with the Repo Rate are at around 115 bps to 120 bps. However, any signs of rate hikes will push up bond yields sharply higher across the curve.
Government bond yield curve flattened last week with long end yields flat to down and 10 year bond yields up sharply. The ten year benchmark bond, the 6.97% 2026 bond saw yields rise by 9bps week on week to close at levels of 6.91%. The old ten year benchmark bond, the 7.59% 2026 bond also saw yields rise by 9bps to close at 7% levels while the 7.88% 2030 bond saw yields rise by 4bps to close at 7.33%. The 8.13% 2045 bond saw yields fall by 1bps to close at 7.51%. 10 year bond yields will rise on RBI liquidity measures and hawkish policy stance.
OIS market saw one year and five year OIS yields rise by 5bps each last week. One year OIS yield closed at 6.48% while five year OIS yield closed at 6.73%. OIS curve could flatten on RBI liquidity measures and hawkish policy minutes. .
10 year benchmark AAA bond yields closed lower by 3bps at 7.68% levels with spreads down by 12bps at 65bps levels. Benchmark 3 year AAA corporate bond yields closed flat at 7.33% levels. Credit spreads fell by 6 bps to close at 51 bps levels. 5 year benchmark AAA bond yields closed flat at 7.46% with spreads down by 12bps at 45ps levels. Credit spreads could rise on RBI MSS and CMB auctions but will then fall again as markets search for yields.
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 4509 billion as of 21st April 2017. The surplus was Rs 4119 billion in the week previous to last. Liquidity is rising on government spending and RBI fx purchases, which is being neutralized by MSS and CMB auctions.