The government bond yield curve shifted higher last week as the market sold off on account of nervousness over liquidity, elections and next fiscal’s government borrowing. The five year benchmark bond, the 7.28% 2019 bond saw yields rise by 9bps while the ten and thirteen year benchmark bonds, the 8.83% 2023 and 8.28% 2027 bonds saw yields rise by 8bps and 16bps respectively. Volumes in the market came off by 27% week on week.
The bond market in taking up yields last week ignored bond positive data. Inflation as measured by the CPI (Consumer Price Index) and WPI (Wholesale Price Index) came off for the month of January 2014. CPI fell to its lowest level in two years as it printed at 8.79% against levels of 9.87% seen in December 2013. Falling vegetable prices with the index down 13.3% in January 2014 helped CPI come off and with vegetable prices staying soft, CPI could trend down further in the coming months. However core CPI that is ex food and fuel stayed sticky at 8.2% levels. Core CPI has been hovering around 8% levels for a while and RBI does keep an eye out on this measure of inflation.
The WPI came off to 6 months low of 5.05%, largely led by falling food prices. Food price inflation was at 6.84% in January 2014 against 13.68% seen in December 2013. Core WPI that is non food manufacturing WPI rose to 3% from levels of 2.7%. Core WPI is well within RBI’s comfort zone of 5% and below.
IIP (Index of Industrial Production) growth for December 2013 was a negative 0.6% while manufacturing growth was a negative 1.6%. The IIP growth for April-December 2013 was a negative 0.1% against 0.7% growth seen in the same period last year. Manufacturing growth was a negative 0.6% against growth of 0.6% seen last year. IIP growth indicates the weakness in the economy that is expected to grow at 4.9% for fiscal 2013-14 against growth levels of 4.5% seen in fiscal 2012-13.
Economic growth outlook is weak given issues of political uncertainty, lack of government spending, lack of private sector investments and continued rise in non performing assets of public sector banks .
The government is running a surplus of over Rs 50,000 crores at present and this surplus is expected to go up to Rs 120,000 crores on the back of inflows from advance tax and spectrum auctions that saw Rs 61,000 crores worth of bids. Government is not spending as elections are drawing close and to stick to fiscal deficit target of below 4.8% of GDP. Government cancelled an Rs 15,000 crores bond auction as it did not require the funds.
The government is presenting a Vote-on-Account to the parliament on the 17th of February where it will detail its expenditure. A full budget will be presented by the government that is formed post elections in May 2014. The market is not expecting the government to borrow heavily in the next three to four months.
Given the bond positive data on inflation, growth and government borrowing the sell off in bonds is unwarranted at the moment.
Liquidity tightened last week with the market borrowing Rs 1462 billion from the RBI against borrowing of Rs 1100 billion seen in the week before last. The market is borrowed Rs 386 billion in the LAF (Liquidity Adjustment Facility) window, Rs 186 billion in the MSF (Marginal Standing Facility) window and Rs 890 billion in the term repo window. Liquidity will stay tight till end March 2014.
Five and ten year benchmark AAA corporate bond yields rose 3bps each week on week while five and ten year credit spreads fell by around 6bps and 5bps to close at levels of 54bps to 63bps respectively. Corporate bond yields are likely to stay sticky at current levels given that markets will trade government bonds in a range.
OIS (Overnight Index Swaps) market saw the curve shift up on the back of rising government bond yields. One and five year OIS yields rose by 6 bps and 8 bps respectively to close at levels of 8.73% and 8.50% and the five over one OIS spread flattened by 2bps to close at 23 bps levels. OIS yields are likely to stay ranged at current levels given lack of clarity on the direction of government bond yields.