Ten year bond yields have fallen sharply from the US to Germany over the last one month. Will the fall in global ten year bond yield feed into the 8.40% 2024 bond that is trading at levels of 8.57%, which is up 17bps over the last one month?
US ten year treasury yields have fallen by 16bps over the last one month and at 2.34% levels is trading at 14 months low. German ten year bund yields are down 26bps over the last one month and is trading at all time low levels of 0.88%. Ten year bonds of UK, France, Italy and Spain are down 21bps, 30bps, 23bps and 26bps over the last one month. Japanese ten year bonds are down 4bps and are trading at levels of 0.48%.
The rally in ten year bond yields across the globe signifies that markets are betting on slow economic recovery and easy central bank policies. US ten year treasury yields have dropped despite the Fed looking to stop asset purchase by October this year and looking to raise interest rates starting early 2015.
Geo political tensions from Ukraine to Iraq are also contributing to the rally in ten year bond yields.
The global ten year bond rally is yet to feed into the yields on the benchmark ten year bond, the 8.40% 2024 bond. The yield on the bond has gone up despite FIIs being net buyers of USD 2.8 billion of bonds in August. The reduction of first half government borrowing by Rs 160 billion has also not contributed to a bond rally.
The bond market is a bit wary of the impact of reduction in SLR (Statutory Liquidity Ratio) by the RBI. SLR has been cut by 100bps over the last two months from 23% to 22% of NDTL (Net Demand and Time Liabilities). RBI also cut the HTM (Held to Maturity) portfolio of banks by 50bps to 24% from 24.5% of NDTL. The bond market is expecting the RBI to bring down HTM portfolio limit to 22% of NDTL to keep it in line with the SLR.
Lower SLR and lower HTM limits reduce demand for government bonds by banks and given continuous supply of bonds by the government, there could be a demand supply gap that may not be filled leading to rising yields.
RBI selling of bonds from its books is also impacting market sentiments. RBI has sold Rs 60 billion of bonds since May 2014 and would sell more if it wants to sterilize liquidity infused through USD purchase. RBI has bought USD 8.2 billion in the April-June 2014 period.
The bond market will not bring down the yield on the 8.40% 2024 bond in a hurry given worries on demand and RBI bond sales. However, the market will not be short the 8.40% 2024 bond given low global bond yields and strong FII demand for INR bonds. The 8.40% 2024 bond would trade in an 8.40% to 8.60% range till some trigger that could lead to a breakout.
OIS market saw the yield curve staying almost flat week on week. One year OIS yield stayed flat at 8.46% levels while five year OIS yield rose by 1bps to close at levels of 8.46% and 8.034% respectively. Expected liquidity tightening in September on advance tax outflows will keep one year OIS yields at higher levels while global bond rally will bring down five year OIS yields.
Liquidity held steady last week. Liquidity as measured by banks bids for LAF (Liquidity Adjustment Facility) repo, reverse repo and term auctions, banks drawdown from MSF (Marginal Standing Facility) and Export Credit Refinance was at deficit of Rs 850 billion last week, up marginally by Rs 15 billion from Rs 835 billion deficit seen in the week previous to last. Liquidity deficit is likely to come off on government spending but will trend up on advance tax outflows in September.