Risk appetite in bond markets that was extremely low prior to 29th February budget 2016-17, has gone up considerably post budget. Bond yields have dropped by 30bps to 40bps in the five to thirty year segment of the government bond yield curve with the curve flattening by around 10bps in the ten over thirty segment of the curve. The flattening of the yield curve with long bond yields dropping sharply suggests that the market is in an extremely bullish mode and long positions will be rewarded going forward with more positives such as the rate cuts on small savings and benign first half borrowing program.
Bond yields had dropped post budget on expectations of RBI rate cut, fall in global bond yields, ECB easing policy and Fed going slow on rate hikes. The government sticking to fiscal deficit target of 3.5% of GDP for fiscal 2016-17, negative IIP growth for January 2016 and fall in CPI inflation from 5.69% in January 2016 to 5.18% in February 2016 has prompted markets to bet on rate cuts by the RBI. Global bond yields had fallen sharply over the last two months as Bank of Japan joined a host of other central banks in adopting negative interest rates. Japanese government ten year bond yield is trading at levels of -0.1% while US and European bond yields have fallen by around 40bps on fears of low growth.
ECB in its policy meet this month cut rates to record low of zero percent, cut discount rates to negative 0.4% and increased the size of its QE by Euro 20 billion to Euro 80 billion a month. Cheap Euro liquidity flooding markets added to global risk appetite for higher yielding assets helping turn sentiments on Indian bond yields.
The Fed in its policy meet last week highlighted concerns on global growth affecting the US economy and guided for a slower pace of rate hikes than the 100bps rate hike guidance for 2016 given in December 2015. Fed going slow on rate hikes takes out fears of capital outflows from emerging markets including India.
The government cut small savings rates post trading hours on Friday the 18th March and RBI released a benign borrowing program for the first half of fiscal 2016-17.
The small savings rate cut and benign borrowing program will spur bond markets to take down bond yields further. The yield on the ten year benchmark government bond could well touch 7% levels from current levels of 7.52% over the course of the next few months.
Government bond markets saw yields closing down last week. The 7.72% 2025 bond saw yields falling by 8bps to close at 7.71% levels while the new benchmark ten year bond, the 7.59% 2026 bond saw yields closing down by 11bps at 7.52% levels. The 8.27% 2020 bond saw yields falling by 11bps to close at 7.60% levels. The 7.88% 2030 bond saw yields falling by 13bps to close at 7.87% levels while the 8.13% 2045 bond saw yields falling by 19bps to close at 8.01% levels.
OIS market saw one year and five year OIS yields fall by 7bps and 12bps week on week to close at 6.88% and 6.68% respectively. OIS yields fell on the back of rally in government bond yields and will fall further this week on the back of small savings rate cut and benign government borrowing program for the first half of the coming fiscal year.
Benchmark AAA three year corporate bond yields fell last week on positive market sentiments. Three year bond yields fell 12bps to close at 8.06% levels with spreads up by 1bps at 39bps levels. Five year bond yields were down 17bps at 8.28% with spreads down by 5bps at 54bps levels while ten year bond yields were down 20bps at 8.36% with spreads down 8bps at 70bps levels. Corporate bond yield curve will flatten as market searches for yields amidst accommodative monetary policy.
Liquidity conditions are tight with 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) in deficit of Rs 2132 billion as of 18th March. The deficit was Rs 1391 billion in the week previous to last. Government surplus was at levels of Rs 1921 billion last week, higher by Rs 1000 billion week on week on advance tax inflows. Liquidity will stay tight this week on holidays and fiscal year end considerations