The Brexit vote pulled down Sensex and Nifty by over 2% each while the INR fell by around 1%. The bond market however, saw yields fall, a reaction that was quite unexpected. The common perception was that Brexit will fuel capital outflows, weakness in the INR and FII selling in INR Bonds. Why did bond yields fall on Brexit and how is Brexit beneficial for INR Bonds?
The primary reason bond yields fell on Brexit is the expectation of Global Central Banks pumping in liquidity to calm stressed financial markets. Brexit is also taking out all bets on Fed rate hikes this year as Janet Yellen the Fed Chair had said that Brexit can be negative for the US economy. Global bond yields fell sharply with ten year US treasury and German bund yields falling by 19bps and 14bps respectively and Japanese bond yields falling 3bps deeper into negative territory.
The sharp fall in global bond yields drove down OIS yields with one and five year OIS yields falling by 12bps and 10bps respectively.
The global economic repercussions of Brexit being seen as negative will lead to expectations by the bond markets for the incoming RBI governor, whoever it may be, to cut rates. Commodity prices including oil prices fell post Brexit on demand worries and this lowers inflation expectations.
Given that the Fed will be more dovish than hawkish post Brexit and other central banks will keep ultra loose monetary policies and the fact that RBI may resort to rate cuts to lower the economic impact of Brexit, INR bond yields can trend down in the coming weeks.
The benchmark ten year bond, the 7.59% 2026 bond saw yields closing down by 3bps at 7.47% levels last week. The 8.27% 2020 bond saw yields closing down by 1bps at 7.31% levels. The 7.88% 2030 bond and 8.13% 2045 bond saw yields closing down by 5bps and 2bps respectively to close at 7.73% and 7.82%. Bond yields are likely to trend down on RBI rate cut expectations.
OIS market saw one year OIS yields close down by 12bps and five year OIS yields close down by 10bps week on week. One year OIS yield closed at 6.57% while five year OIS yield closed at 6.68%. OIS yield curve will fall on rate cut expectations.
Benchmark AAA corporate bond yields closed flat last week. Three year bond yields closed flat at 7.93% levels with spreads up by 5bps at 66bps levels. Five year bond yields closed flat at 8.06% with spreads up by 1bps at 57bps levels while ten year bond yields closed down by 2bps at 8.26% with spreads flat at 64bps levels. Corporate bond yields will fall on 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) was in deficit of Rs 390 billion as of 24h June. The deficit was Rs 694 billion in the week previous to last. Government surplus was Rs 272 billion last week, up by Rs 272 billion week on week. Liquidity eased on RBI OMO bond purchases and purchase of USD.