The bond market is expecting the RBI to lower the Repo Rate in the next calendar year but the RBI could well oblige the market in its 2nd December 2014 policy review. RBI has reasons to cut the Repo rate given that CPI (Consumer Price Index) inflation fell to record lows of 5.52% in October 2014 and WPI (Wholesale Price Inflation) fell to six year lows of 1.77%. IIP (Index of Industrial Production) growth at 2.8% for the April-September 2014 period is in low single digits indicating weak economic recovery.
Global oil prices are down over 25% over the last ten months on global economic worries and rising supply.
Central banks are lengthening their stimulus with Bank of Japan increasing asset purchases, ECB increasing its balance sheet size and Fed committing to low rates for a longer period of time.
The INR has been stable at around Rs 61- Rs 62 to the USD despite the USD index rising to multi year highs on the relative strength of its economy. Capital flows have been strong with FIIs buying USD 17 billion of INR bonds and USD 11 billion of equities in the April-November 2014 period.
The fact that CPI and WPI are at lows due to high base effect with CPI and WPI inflation trending at levels of 10.17% and 7% last October could weigh on RBI’s decision to postpone rate cuts. November would see a larger base effect as CPI and WPI inflation for November 2013 was 11.24% and 7.52% respectively. However given core inflation staying at below 6.5% for CPI and below 3% for WPI could influence RBI to lower rates in December.
The bond market is going bullish into the policy review given that it has flattened yield curves. Rate cut by the RBI would lead to the yield curve shifting down with a steepening bias.
Government bond yields closed higher week on week as the market took profits at lower levels of yields. Five year benchmark bond, the 7.28% 2019 bond saw yields move up by 5bps to close at 8.24% levels while ten year benchmark bond, the 8.40% 2024 bond saw yields close up 2bps at 8.22% levels. The long bond, the 9.23% 2043 bond saw yields close up 2bps at 8.31% levels. Government bond yields are likely to come off as markets build positions into the 2nd December RBI policy review on expectations of outside chance of rate cuts.
OIS yield curve rose last week with five year OIS yield rising by 7bps to close at levels of 7.48% and one year OIS yield rising by 6bps to close at levels of 8.08%. OIS market reacted to profit taking in government bonds. One year OIS yield could benefit if RBI lowers rate in its 2nd December policy review.
System liquidity tightened last week on government bond and CMB (Cash Management Bills) auction outflows of Rs 270 billion. 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 483 billion last week from Rs 163 billion seen in the week previous to last. Liquidity is likely to ease on government spending.