Government bond yields rose last week on the back of multiple issues hurting bond market sentiments. 10 year US Treasury yields rose by 15bps last week on the back of hawkish comments by both Janet Yellen the Fed Chair and Mario Draghi the ECB President. Both the Central Bankers noted optimism in their respective economies and sounded out withdrawing of stimulus. Fed has raised rates four times and is talking about lowering the balance sheet size while ECB is still maintaining policy accommodation with policy rate at 0% and monthly bond purchases of Euro 60 billion.
Government has been spending heavily in the first quarter of the fiscal year and has been drawing down on WMA from the RBI. RBI has fixed the July-September WMA limits at Rs 700 billion, indicating that the government may need to borrow heavily in the short term from RBI to meet its spending requirements.
The heavy spending by the government is adding to system liquidity, which is already high on demonitzation surplus. RBI has been sucking out liquidity through reverse repo and through issue of CMB (Cash Management Bills). However, RBI believes that there is long term liquidity in the system that requires to be drained and has announce an OMO sale auction for Rs 100 billion this week.
OMO sales add to supply of bonds in the market and the announcement will lead to short term negative sentiments in the bond market. Bond yields are likely to rise this week but the market will tend to buy into yields at higher levels on expectations of rate cuts in the RBI August policy review.
Government bond yields rose last week on negative market sentiments. The new benchmark 10 year bond, the 6.79% 2027 bond saw yields close up by 5bps week on week at levels of 6.51%. The old 10 year benchmark bond, the 6.97% 2026 bond, saw yields close up by 4bps at 6.68% levels while the on the run bonds, the 6.79% 2029 bond and the 7.06% 2046 bond saw yields close up by 6bps and 7bps respectively at levels of 6.78% and 7.12%. Gsec yields are likely to rise on OMO sale announcement.
Five year OIS (Overnight Index Swap) yield rose by 8bps week on week to close at levels of 6.29%. One year OIS yield rose by 5bps to close at 6.25%. The OIS yield curve has steepened on the back of rise in US treasury yields. OIS yields will rise on weak bond market sentiments.
10 year benchmark AAA bond yields rose by 7bps week on week to close at 7.45% levels with spreads up by 1bps at 78bps levels against the new 10 year benchmark gsec, the 6.79% 2027 gsec. 3 year AAA spreads rose by 4bps at 66bps while 5 year AAA spreads were down by 5bps at 57bps. Benchmark 3 year AAA corporate bond yields closed up by 10bps at 7.28% levels. 5 year benchmark AAA bond yields closed flat at 7.28%. Credit spreads are likely to come off on search for yields amidst high 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 4467 billion as of 30th June 2017. The surplus was Rs 4350 billion in the week previous to last. Liquidity will stay high on the back of government spending.