Stay liquid, no directional bets and take carry will be bond traders mantra over the next few weeks. Going on holiday would be the best option!!
Bond traders really do not know what do now in the market. Bond yields have backed up sharply since RBI 8th February 2017 policy, where the central bank changed its stance from accommodative to neutral. The 10 year benchmark bond, the 6.97% 2026 bond saw yields rising by 45bps post policy while the longer bonds, the 7.88% 2020 bond, the 7.73% 2034 bond and the 7.06% 2046 bond saw yields rise by 44bps, 43bps and 41bps respectively. The five year benchmark bond, the 6.84% 2022 bond saw yields rise by 32bps. The gsec yield curve has shifted upwards with a bit of steepening seen in the 5 years to 10 years segment of the curve.
The sharp rise in yields has made it difficult for traders to short bonds, as immediately there is no incremental data to support shorts. India’s IIP growth was negative for December 2017 and CPI inflation fell in January 2017 on demonetization effects. RBI governor Dr. Urjit Patel was non committal on future rate actions in an interview last week. US 10 year yields have held steady at around 2.40% to 2.50% levels despite higher probability of Fed rate hikes in March.
The willingness to go long bonds at higher yields is also low in the market. There are events coming up that could pressure bond yields upwards. President Donald Trump’s tax cut plan for the US economy could lead to growth expectations revised upwards and with that inflation expectations could rise. Fed could hike rates in March and signal faster pace of rate hikes, which could take the US 10 year treasury yield to 3%.
India’s state election results of key states will be out in March and if the ruling NDA party led by BJP gets unfavorable results, the government could turn more populist, which in turn would affect inflation expectations. The market would also watch the government borrowing for the 1st half of 2017-18 as the government has to refinance close to Rs 1750 billion of bonds that are coming up for maturity in the April-September 2017 period.
Bond traders would prefer to preserve capital rather than taking unnecessary directional bets in the market. Market volumes will be low and yields tightly ranged. Wherever there is possibility of earning carry by investing in bonds that provide low volatility, which is largely in the below 3 years maturity segment of the curve, bond traders will receive the carry. Liquidity on positions will be the preference of traders, as events will require quick change of positions.
The ten year benchmark bond, the 6.97% 2026 bond saw yields rise by 5bps week on week to close at levels of 6.85%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields rise by 3bps to close at 7% levels while the 7.88% 2030 bond saw yields rise close flat at 7.41%. The 8.13% 2045 bond saw yields rise by 1bps to close at 7.54%. Bond yields will trade in a tight range in the coming weeks.
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 6.41% while five year OIS yield closed at 6.65%. OIS yield curve will steepen as markets worry about Fed rate hikes.
Credit spreads closed mixed last week. 3 year benchmark AAA corporate bond yields closed flat week on week at 7.08% levels. Credit spreads rose by 2 bps to close at 39bps levels. 5 year benchmark AAA bond yields rose by 13bps to close at 7.36% with spreads up 12bps at 47bps levels. 10 year benchmark AAA bond yields closed flat at 7.58% levels with spreads down by 5bps at 61bps. Credit spreads will stay ranged over the next couple of weeks till events unfold in March.
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 5648 billion as of 17th February 2017. The surplus was Rs 5937 billion in the week previous to last. MSS bonds outstanding were Rs 1500 billion. Rise in currency in circulation on RBI easing limits on cash withdrawals lowered system liquidity. Liquidity will continue to trend down as more cash goes out of the system.