20 Jan 2019

Fiscal Worries & Higher Crude Oil Prices Drive INR Lower

The INR posted a second consecutive weekly loss against the USD, largely due to foreign fund outflows, higher crude oil prices, stronger USD and concerns over an expansionary fiscal policy in the upcoming budget.

author dp
Team INRBonds
Share via:LinkedIn LogoTwitter logo

The INR posted a second consecutive weekly loss against the USD, largely due to foreign fund outflows, higher crude oil prices, stronger USD and concerns over an expansionary fiscal policy in the upcoming budget. INR depreciated by 0.97% against the USD last week and depreciated by 0.01% against the euro

The INR has come under renewed pressure after global oil prices rebounded from December lows on supply cuts by the producers club, OPEC and Russia. Oil prices are up nearly 20% since hitting an 18-month low in late December. Higher crude prices places pressure on India’s current account as well as fiscal deficit and thus hurts the INR.

Further, the data released last week showed that retail inflation has fallen to an 18-month low of 2.19% in December on account of lower food prices. However, core inflation continues to remain elevated at 5.7%, mainly on account of higher education and healthcare costs. Weak November industrial data coupled with benign inflation is likely to strengthen the case for RBI rate cut. INR also fell on worries that the government may exceed its fiscal deficit target for fiscal 2019-20 in its interim budget in February. Government bond yields rose on higher market borrowing worries prompting FIIs to sell bonds, leading to fall in INR. Read our Weekly Fixed Income Report for details.

USD snapped a four-week losing streak amid release of upbeat U.S. economic data and improvement in trade optimism after reports suggests that U.S. Treasury Secretary Steven Mnuchin is in favour of easing tariffs on Chinese products. USD Index (DXY), which tracks the movement of the USD against six major currencies, rose by 0.70% on a week on week basis and is at a level of 96.34.

The trade sentiment improved further on Friday after Chinese officials reportedly offered to boost annual imports of U.S. goods by a combined value of more than USD 1 trillion in a bid to cut its surplus with the U.S. The news boosted the expectation that the stalemate between the U.S. and China may be resolved sooner rather later, prompting a rally in risk assets.

USD started the week on slightly lower note,  as demand for safe haven Yen rose after the release of weak economic data from China, which fuelled concerns that the world’s second largest economy is slowing. Further, the USD came under additional pressure amid heightened expectations that the Federal Reserve will hold off on raising rates this year due to weakness in global growth.

USD received support during mid of the week as euro and pound turned lower after the data released showed that Germany’s economy slowed in 2018 and UK Prime Minister Theresa May’s Brexit deal was voted down by a hefty margin. The withdrawal deal, which sets out the terms of the U.K.’s exit from the European Union, received 202 votes for and 432 against. The no votes included 118 Conservative Party rebels.

The pound received some support at lows after U.K. Prime Minister Theresa May’s government managed to survive a vote of no-confidence.

USD continued to rally on Friday after the release of upbeat U.S. economic data and as the market sentiment remained subdued amid concerns that the U.S. government shutdown is beginning to take a toll on the economy.

The data that  was released in U.S. last week was better, but there’s no doubt that the trend of growth is lower. Manufacturing activity improved in the Philadelphia region, activity eased to its lowest level since May 2017 in the NY area. Producer prices dropped less than expected but declined for the first time in 4 months. Consumer confidence also hit a 2-year low according to the University of Michigan, which is concerning because sentiment has a direct impact on spending. Major reports such as retail sales and the trade balance have been delayed due to the shutdown and while government shutdowns does not tend to inflict lasting damage on the economy, it’s never gone on for this long.

Weekly Global Bond Market Analysis

US 10-year benchmark bond yields rose by 10 bps, as stock markets rallied after reports that the U.S. is debating to end its tariff war with China. The news eases fear about a potential trade war. Stock markets received a boost from a report by The Wall Street Journal saying U.S. officials were considering to roll back the import levies on Chinese goods to calm down the market’s fears on a potential trade war. Both Beijing and Washington are looking to resolve current negotiations before a March deadline when tariffs on $200 billion of Chinese imports are slated to rise to 25% from 10%.

Japan 10-year benchmark bond yields fell by 1 bps after CPI inflation in Japan fell to the lowest level since May-18. CPI Inflation in December fell to 0.7% from 0.9% in November, BoJ inflation target is 2%. Market expects as inflation to remain well below the BoJ target and  chances of tighter monetary policy have diminished.

UK 10-year benchmark bond yields rose by 6 bps after UK lawmakers voted 432 to 202 to reject Theresa May Brexit deal to leave the EU. Theresa May has to present a new plan for Brexit to U.K.’s Parliament till 21st January.

Italy 10-year benchmark bond yields fell by 12 bps after successful Italian debt sale, which boosted market sentiments. Italy auctioned 15-year bond worth 10 billion euros and received bids of around 35.5 billion euros from investors.

Greece 10-year benchmark bond yields fell 11 bps after Prime Minister Alexis Tsipras won a confidence vote in parliament. His narrow victory averted a possible snap election. Greece is planning to enter  the debt market and recent Italy debt sale result will provide the confidence to Greece.

Portugal 10-year benchmark bond yields fell by 22 bps and Spain 10-year benchmark bond yields fell by 8 bps

Emerging economies 10-year benchmark bond yields were mixed last week.

China 10-year benchmark bond yields fell by 2 bps after PBoC pumped in a net 560 billion yuan into the financial system, the biggest open market operation by PBoC ever. PBoC is also guiding interbank borrowing cost down without cutting the benchmark interest rate, the logic behind this is to provide cheap funding to banks to allow them to lend to companies at lower rates.

South Africa 10-year benchmark bond yields rose by 12 bps, South Arica central bank kept its interest rate unchanged at 6.75% and trimmed its projection for policy tightening. The Reserve Bank quarterly projection model now prices only one 25 bps rate hike by the end of 2021, compared with three rate hikes by the end of 2020, forecast in November 2018.

Russia 10-year benchmark bond yields fell by 10 bps. Australia 10-year benchmark bond yields rose by 4 bps, Brazil 10-year benchmark bond yields fell by 5 bps, Indonesia 10-year benchmark bond yields rose by 12 bps.

US high-yield bond yields fell by 12 bps to 7.01% and Eurozone high-yield bond yields fell by 20 bps to 4.39%.