The strong US February job numbers have in all probability confirmed a 25bps rate hike by the Fed in its meeting this week. US 10 year treasury yields closed at close to 2.60%, levels that were last seen in September 2014. Fed would guide for faster pace of rate hikes given the strength of the US economy and the fact that inflation could rise faster than expected on wage push effect as the economy is running at an unemployment rate of 4.7%, which is at par with long term averages.
The 10 year benchmark bond, the 6.97% 2026 bond would see yields rise over 7% levels if the Fed guidance hits global bond markets hard. Global bond yields have trended up sharply over the last few months on strong economic data in US and Eurozone.
The 6.97% 2026 bond has see yields rise by 70bps over the last three months and by 50bps over the last one month as RBI held rates and changed its policy stance from accommodative to neutral. Markets may worry about a rate hike in April if RBI views the Fed rate hikes as negative. However once the dust settles on Fed and RBI policy is done with, markets will start looking at the 10year gsec as an attractive play on yields.
The bond market would see the resounding state election win for the Modi government in the key state of UP as a continuation of its focus on fiscal consolidation. The government has projected a lower fiscal deficit of 3.2% of GDP for fiscal 2017-18 and at 3% for fiscal 2019-20. The government need not resort to populist measures to ensure re-election in 2019 given its strong showing in state elections post demonetization.
Government borrowing too would not be as heavy as initially feared as the government has brought down its redemption liability for the next year post switches and repurchase of bonds and its total redemption liability is around Rs 1665 billion.
The ten year benchmark bond, the 6.97% 2026 bond saw yields rise by 13bps week on week to close at levels of 6.90%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields rise by 18bps to close at 7.14% levels while the 7.88% 2030 bond saw yields rise by 10bps to close at 7.58%. The 8.13% 2045 bond saw yields rise by 5bps to close at 7.64%. Bond yields will be pressured on Fed rate hike expectations.
OIS market saw one year OIS yield close flat and five year OIS yield close down by 3bps week on week. One year OIS yield closed at 6.44% while five year OIS yield closed at 6.71%. OIS yield curve will steepen as markets worry about Fed rate hikes.
Credit spreads closed mixed last week. 10 year benchmark AAA bond yields closed higher by 8bps at 7.96% levels with spreads down by 9bps at 94bps Benchmark 3 year AAA corporate bond yields closed higher by 10bps week on week at 7.38% levels. Credit spreads fell by 2 bps to close at 54bps levels. 5 year benchmark AAA bond yields closed higher by 15bps at 7.68% with spreads up 4bps at 64bps levels. Market will look to buy into spreads at higher levels given strong system liquidity.
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 5100 billion as of 10th March 2017. The surplus was Rs 6027 billion in the week previous to last.MSS bonds outstanding were Rs 500 billion. Rise in currency in circulation on RBI easing limits on cash withdrawals will bring down system liquidity.