The post policy reaction by markets was a steepening of the yield curve on both corporate bonds and government bonds. Three and five year benchmark AAA corporate bond yields fell by 7bps each last week while ten year bond yields stayed flat. The well traded 8.27% 2020 government bond yield fell 4bps last week while the ten, fifteen and thirty year bond yields stayed flat.
The yield curve steepening post policy is due to the fact that liquidity will be kept easy in the system while benchmark policy rates will be kept stable.
The release of IIP data for April 2016 will further add to the yield curve steepening. IIP for the month of April 2016 fell 0.8% on a year on year basis as compared to 3% growth seen last year and 0.1% growth seen in March 2016. Manufacturing index fell 3.1% in April against 3.9% growth seen last year and a fall of 1.2% seen in March. The weak IIP data was unexpected as the economy is showing signs of improvement as highlighted in RBI’s policy review.
CPI inflation is expected at over 5.5% for the month of May against 5.39% levels seen in April. RBI has highlighted concerns on inflation in its policy review. Weak IIP numbers coupled with rising inflation suggest a steepening of the yield curve, as RBI will refrain from any rate cuts till inflation expectations drop but will keep policy accommodative through 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) was in deficit of Rs 130 billion as of 3rd June. The deficit was Rs 20 billion in the week previous to last. Government surplus was Rs 162 billion last week, up by Rs 125 billion week on week. Advance tax outflows will lead to deficit rising this week.
The benchmark ten year bond, the 7.59% 2026 bond saw yields closing flat at 7.49% levels last week. The 8.27% 2020 bond saw yields closing down 4bps at 7.31% levels. The 7.88% 2030 bond and 8.13% 2045 bond saw yields closing flat at 7.77% and 7.84% respectively. Government bond yield curve will steepen if CPI inflation numbers come in higher than expected.
OIS market saw one year OIS yields close flat and five year OIS yields falling by 3bps week on week. One year OIS yield closed at 6.68% while five year OIS yield closed at 6.76%. OIS yield curve will steepen on inflation printing higher than estimates.
Benchmark AAA corporate bond yields closed mixed last week. Three year bond yields closed down 7bps at 7.91% levels with spreads down by 6bps at 57bps levels. Five year bond yields closed down 7bps at 8.01% with spreads down 3bps at 56bps levels while ten year bond yields closed flat at 8.25% with spreads unchanged at 62bps levels. Corporate bond yields will tend to fall as the short end of the curve as liquidity improves.