Slowing export growth, falling CPI inflation and weak IIP data points to a 50bps rate cut by the RBI in its policy review in August 2017. GST implementation, while smooth, can hurt growth numbers in this quarter as many businesses are still grappling with the new tax regime and have gone slow on BAU (Business As Usual).
RBI will also take comfort from Fed Chair Janet Yellen’s comments on uncertain outlook on inflation that would give the Fed time to normalize policy gradually.
RBI had forecast inflation between 2% to 3.5% in the 1st half of 2017-18 and June’s print of 1.54% is below RBI’s forecast and also below RBI’s target of 4% +/- 2%. One single month’s number may not unduly concern RBI but the fact is that inflation coming in below 2% and core inflation at around 4% will prompt the MPC (Monetary Policy Committee) to give a 50bps rate cut as a signal that inflation outlook is weak.
Government bond yields fell last week on the back of falling inflation The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close down by 6bps week on week at levels of 6.47%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close down by 5 bps at 6.67% levels while the on the run bond, the 6.79% 2029 bond saw yields close down by 6bps to close at 6.77%. The long bond, the 7.06% 2046 bond saw yields close down by 4bps at levels of 7.08%. Gsec yields will fall further on rate cut expectations.
OIS market saw one year yield close down by 3bps and five year OIS yield closed down by 6bps last week. One year OIS yield closed at 6.22% while five year OIS yield closed at 6.27%. OIS yields will move down on rate cut expectations.
Corporate bond yields fell last week on the back of falling inflation. 10 year benchmark AAA bond yields closed lower by 5bps at 7.38% levels with spreads up by 3bps at 82bps levels against the new 10 year benchmark gsec, the 6.79% 2027 gsec. 3 year AAA spreads were lower by 3bps at 55bps and 5 year spreads were higher by 10bps at 56bps. Benchmark 3 year AAA corporate bond yields closed lower by 10bps at 7.13% levels. 5 year benchmark AAA bond yields closed flat at 7.23%. 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 4883 billion as of 14th July 2017. The surplus was Rs 5424 billion in the week previous to last. Liquidity will stay easy on government spending and RBI fx purchases.