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 rose 5bps last week to close at levels of 6.46% on the back of Fed chair Janet Yellen signaling sustained rate hikes to normalize policy. Ten year US treasury yields rose by 10bps last week on the back of Yellen’s statement.
The 6.97% 2026 bond yield will largely trade higher from current levels as markets maintain light position on the back of important events ahead.
Yellen’s comments on rate hikes could see the Fed hiking rates in its meet on the 31st of Jan and 1st of Feb. Bond markets had earlier factored in first rate hikes of 2017 in June but have brought forward the expectations on Fed statements and good economic data. Trump administration will also be sounding out fiscal policies that could boost growth and inflation expectations in the economy. President Donald Trump in his speech in the inauguration on the 20th of January called for GDP growth of 4%, well above current levels of around 2%.
Union budget 2017-18 will have positives and negatives for the bond market. Positives will be in the form of higher tax revenues as GST is implemented in July 2017 while negatives could be in the form of fiscal deficit being kept at 3.5% of GDP against target of 3% of GDP.
RBI policy review on the 8th of February 2017 will see the Central Bank working out the effects of the budget and expected Fed rate hikes on inflation expectations. At this juncture, markets are not expecting any policy action on the 8th of February though cuts are possible if budget keeps down government borrowing and expected Fed rate hikes do not have any large negative impact on capital flows and INR.
The ten year benchmark bond, the 6.97% 2026 bond saw yields rise by 5bps week on week to close at levels of 6.46%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields rise by 5bps to close at 6.60% levels while the 7.88% 2030 bond and the 8.13% 2045 bond saw yields rise by 7bps and 3bps respectively to close at levels of 6.94% and 7.15%. Bond yields will trend higher on event uncertainties.
OIS market saw one year OIS yields close up by 3bps and five year OIS yields close up by 5bps week on week. One year OIS yield closed at 6.21% while five year OIS yield closed at 6.30%. OIS yield curve will steepen as markets factor in faster pace of Fed rate hikes.
Credit spreads closed largely closed higher last week. Three-year benchmark AAA corporate bond yields closed up by 10bps week on week at 6.93% levels. Credit spreads rose by 7 bps to close at 44bps levels. Five-year benchmark AAA bond yields rose by 3bps to close at 7.13% with spreads flat at 55bps levels. Ten-year benchmark AAA bond yields rose by 8bps to close at 7.32% levels with spreads up by 4bps at 76bps. 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 6662 billion as of 20th January 2017. Currency in circulation rising on the back of higher withdrawals from the banking system brought down liquidity surplus. The surplus was Rs 7576 billion in the week previous to last. MSS bonds outstanding were Rs 4450 billion. Liquidity will stay easy as demonetization inflows stay in the system.