The benchmark 10 year bond, the 6.79% 2027 bond, saw yields falling by 3bps week on week to close at one month lows of 6.43%. The yield on the 10 year bond is likely to trend down to levels of 6.25% prior to RBI’s policy review meet on the 1st and 2nd of August 2017. The bond will factor in a minimum of 25bps Repo rate cut by the RBI in its policy review with a reasonably higher probability of a 50bps rate cut.
Bond market will not be disappointed with a 25bps rate cut as the market will then factor in another 25bps rate cut in RBI’s October policy review. RBI, will not want to be seen as changing monetary policy stance too often, as it changed its stance from accommodative to neutral in February this year. RBI would like to be seen as consistent on its policy stance and with rate cuts, the Central Bank will signal its intention for lower rates for a while to come.
RBI will gain comfort from the Fed, ECB and BOJ to stay put on a low rate policy. Central Banks are not seeing any threat to inflation despite better economic data. Fed will maintain a gradual pace of rate hikes, ECB will first stop bond purchases before hiking rates and BOJ will maintain ultra low rates and bond purchase program given lack of inflation in Japan.
Bond market is also lapping up bond supply. RBI OMO sale auction of Rs 100 billion on the 20th of July saw bids for Rs 800 billion indicating a huge appetite for bonds. Government bond auction of Rs 150 billion on the 21st of July saw bids for 5x the size of the auction. Strong system liquidity is driving the market’s appetite for bonds.
RBI is pushing for approval by the government for its SDF or Special Deposit Facility as a liquidity management tool. RBI is running out of securities for collateral for Reverse Repo and is also unable to sell higher amounts through OMO.
Government bond yields fell last week on the back of rate cut positioning by markets. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close down by 3bps week on week at levels of 6.43%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close down by 3bps at 6.64% levels while the on the run bond, the 6.79% 2029 bond saw yields close down by 7bps to close at 6.70%. The long bond, the 7.06% 2046 bond saw yields close down by 4bps at levels of 7.04%. Gsec yields will fall further on rate cut expectations.
OIS market saw one year OIS yield close down by 4bps and five year OIS yield closed down by 5bps last week. One year OIS yield closed at 6.18% while five year OIS yield closed at 6.22%. OIS yields will move down on rate cut expectations.
Corporate bond yields and spreads fell last week on the back of search for yields. 10 year benchmark AAA bond yields closed lower by 15bps at 7.23% levels with spreads down by 12bps at 70bps levels against the new 10 year benchmark gsec, the 6.79% 2027 gsec. 3 year AAA spreads were lower by 4bps at 51bps and 5 year spreads were lower by 9bps at 47bps. Benchmark 3 year AAA corporate bond yields closed lower by 10bps at 7.03% levels. 5 year benchmark AAA bond yields closed lower by 15bps at 7.08%. Credit spreads are likely to come off further on liquidity and rate cut expectations.
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 4625 billion as of 21st July 2017. The surplus was Rs 4883 billion in the week previous to last. Liquidity will stay easy on government spending and RBI fx purchases.