Bond markets are waiting for Fed meet, Union Budget 2017-18 and RBI policy review all to be held on 1st and 8th of February. The 6.97% 2026 bond yield fell 6bps last week to close at levels of 6.40% on the back of weaker than expected US 4th quarter 2016 GDP growth numbers and expectations of a positive budget on the fiscal deficit front.
US 4th quarter 2016 GDP growth came in at 1.9% against expectations of over 2% growth. US ten year treasury yields fell post the GDP growth number release on expectations that Fed may not hike rates in this week’s policy.
The government looks confident of a strong revenue growth in fiscal 2017-18 as it implements GST and fiscal deficit could still be brought down from levels of 3.5% of GDP seen in this fiscal year.
How will the 10 year gsec yield move as events unfold this week?
Scenario 1 – Most Bearish
The yield could rise by as much as 15bps- 25bps if Fed hikes rates and fiscal deficit is budgeted at 3.5% or 3.3% of GDP. Higher US rates, higher government borrowing would prompt the RBI to keep rates status quo in its policy review as the INR could come under selling pressure.
Scenario 2
Fed rate hike and fiscal deficit of 3% of GDP would keep yields on the 10 year gsec by around current levels of 6.40%. Bias would be towards falling yields rather than rising yields as RBI could cut rates as government sticks to FRBM targets.
Scenario 3
Fed keeping rates on hold and fiscal deficit at 3.5% or 3.3% of GDP would lead to a marginal rise in the 10 year gsec yield as immediate nervousness on Fed rate hikes go out of the market but higher than targeted fiscal deficit weighs on government borrowing.
Scenario 4 – Most Bullish
Fed keeping rates on hold and fiscal deficit of 3% of GDP would bring down yields on the 10 year gsec by 25bps as RBI rate cuts will start getting factored into the yields.
The ten year benchmark bond, the 6.97% 2026 bond saw yields fall by 6bps week on week to close at levels of 6.40%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields fall by 7bps to close at 6.53% levels while the 7.88% 2030 bond saw yields fall by 2bps to close at 6.92%. The 8.13% 2045 bond saw yields rise by 2bps to close at 7.17%. Bond yields will move on outcome of Fed Policy and Union Budget on the 1st of Feb.
OIS market saw one year OIS yields close down by 1bps and five year OIS yields close up by 1bps week on week. One year OIS yield closed at 6.20% while five year OIS yield closed at 6.31%. OIS yield curve will steepen as markets factor in faster pace of Fed rate hikes.
Credit spreads closed largely higher last week. Three-year benchmark AAA corporate bond yields closed down by 5bps week on week at 6.88% levels. Credit spreads rose by 1 bps to close at 45bps levels. Five-year benchmark AAA bond yields fell by 2bps to close at 7.11% with spreads up 2bps at 57bps levels. Ten-year benchmark AAA bond yields rose by 1bps to close at 7.33% levels with spreads up by 7bps at 93bps. Credit spreads are likely to stay ranged until RBI policy on 8th of February.
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 6276 billion as of 27th January 2017. Currency in circulation rising on the back of higher withdrawals from the banking system brought down liquidity surplus. The surplus was Rs 6662 billion in the week previous to last. MSS bonds outstanding were Rs 3500 billion. Liquidity will stay easy as demonetization inflows stay in the system.