Bond markets are distinctly going bullish into the 3rd June 2014 RBI policy review. The auction of the new 14 year bond on the 30th of May saw cut off coming in at 8.60%, below levels of 8.74% traded in the when issued market. The 8.60% cut off on the 2028 bond has skewed the yield curve with the 8.83% 2023 bond trading at levels of 8.64%. The market is shifting out of 8.83% 2023 bond in anticipation of the issuance of a benchmark ten year bond maturing in 2024.
Bond yields fell 3bps to 14bps across the curve last week with the steepest fall in the new 14 year bond that fell from levels of 8.74% traded in the when issued market to 8.60% cut off in the auction. Bond yields have fallen by 50bps since beginning of April 2014, where the RBI left policy rates unchanged but cut amount of borrowing by banks under LAF (Liquidity Adjustment Facility) by 0.25% from 0.50% to 0.25% of NDTL (Net Demand and Time Liabilities).
The bond market is definitely not expecting any positives from the RBI in its 3rd June 2014 policy review. The RBI Governor, Dr. Raghuram Rajan has categorically stated that rates will stay unchanged until the central bank sees the CPI (Consumer Price Index) inflation gliding towards 6% levels from current levels of 8.5%.
CPI could trend down over the next four months on high base effect as food prices had taken inflation from levels of 9.87% in June 2013 to levels of 11.24% in November 2013. However RBI has factored in the base effect in its calculations on CPI and is unlikely to change policy rates on fall in CPI due to base effect.
RBI will note the weak GDP growth numbers for the fourth quarter of fiscal 2013-14. GDP growth was at 4.6% for the fourth quarter and 4.7% for full year 2013-14. Growth was below estimates of 4.9% for full year 2013-14. The central bank will look to address credit growth that is at 13.80% year on year as of May 2014. RBI will make liquidity comfortable in the system for banks to lend to the economy in order to push economic growth.
The initial fears of the bond market on the Modi led government conflicting with the RBI on inflation and growth was eased after the Governor met the Finance Minister Arun Jaitley. The FM is largely on sync with the RBI on lowering inflation expectations and addressing growth slowdown.
The bond market will await sound bytes from the FM on borrowing for this year. Indications are that borrowing could be higher if the government targets a fiscal deficit of 4.5% of GDP for this year against Vote-On-Account estimates of 4.1% of GDP. The market may react negatively to the higher borrowing if it does come about but will then factor in supply absorption capability of borrowing before taking a longer term directional call on yields.
The OIS market saw five year OIS yields closing down 2bps and one year OIS yields rising 2bps week on week to close at levels of 8.10% and 8.40% respectively. The five over one OIS spread inverted by 7bps to close at negative 30bps spread. OIS curve could shift up if market reacts negatively to the Term Reverse Repo auction announced by the RBI on the 2nd of June.
Corporate bond market saw yields fall across the curve with three year, five year and ten year benchmark AAA bond yields falling by around 5bps each. Five and ten year AAA credit spreads fell by 2bps and 6bps respectively to close at levels of 51bps and 45bps. Corporate bond yields are likely to stay sticky at current levels given liquidity in the system while spreads will rise or fall on movement in government bond yields.
Liquidity has eased in the system with market borrowing from RBI under LAF (Liquidity Adjustment Facility) and Term Repo down to levels of Rs 710 billion last week from levels of Rs 750 billion seen in the week before last. RBI is conducting a 4 day Term Reverse Repo auction on 2nd June to suck out excess system liquidity.