The bond market is likely to take some risk off the table at current levels of yields on the back of worries over Iraq tensions, monsoon progress, domestic liquidity and Fed speak. Government bond yields have come off by around 60bps since the beginning of April 2014 as the markets bought into higher levels of yields.
The ten year benchmark bond, the 8.83% 2023 bond is trading at yields of 8.60% while the new issuances of 8.27% 2020 and 8.60% 2028 bonds are trading at levels of 8.32% and 8.48% respectively. Market is awaiting a new ten year bond issuance and if issued, the cut off is likely to come in around levels of 8.30% to 8.35% going by the cut offs of around 8.70% on SDL auctions held last week.
The government bond yield curve is likely to rise in the coming weeks as markets factor in negatives in the environment. However, markets will look to buy at higher levels given expectations of RBI holding rates and government reigning in fiscal deficit in its budget in July.
The ongoing war in Iraq between the government and a military faction has caused oil prices to spike to close to two year highs. Rising oil prices hurt trade deficit, budget deficit and inflation expectations.
Monsoon progress has been slow in India and worries of below normal monsoons are high given El Nino factor. Food prices tend to shoot up on weak monsoons and that leads to rising inflation expectations.
Liquidity is expected to tighten this week on advance tax outflows of around Rs 600 to Rs 700 billion. Banks are borrowing Rs 870 billion from the RBI through LAF and Term Repos. Post advance tax outflows, borrowings are likely to increase to over Rs 1000 billion and that could take up overnight money market rates.
The Fed is expected to continue its USD 10 billion of taper per policy meet next week and asset purchases would come off to USD 35 billion a month from USD 45 billion a month. Fed could also guide markets on its course on rate hikes from abnormally low levels and that may cause short term volatility in markets.
Inflation as measured by the CPI (Consumer Price Index) for the month of May 2014 printed at 8.28%, down from levels of 8.59% seen in April. Inflation is expected to trend down on base effect from June onwards and if the government succeeds in keeping down food prices despite weak monsoons, the fall could be sharp. Core inflation at 7.8% levels is below last fiscal average of around 8%. Inflation is likely to provide comfort to bond markets despite near term issues of Iraq and weak monsoons.
Corporate bond market saw yields rise marginally week on week with three year and five year benchmark AAA bond yields rising by 1bps and 2bps respectively. Ten year yields were unchanged. Credit spreads fell with five year and ten year AAA credit spreads falling by 9 bps and 5 bps to close at levels of 46bps and 31bps respectively. Corporate bond yields are likely to rise marginally on the back of expected rise in government bond yields.
OIS market saw the yield curve shift up with one and five year OIS yields rising by 10bps and 5bps respectively. The five over one OIS spread inverted by 5bps to close at negative 45bps levels. OIS curve is likely to shift up on expected tightening of liquidity and expected rise in government bond yields.