The government bond yield curve is extremely flat with one, five, ten, fourteen and thirty year bond yields trading in an 8.60% to 8.77% band. The market is unsure on which part of the curve to trade on and until a new ten year benchmark bond is floated, the uncertainty will persist. The market uncertainty is highlighted by the sharp upward movement in the yield on the newly issued 8.27% 2020 bond, that was issued at 15bps discount to the 7.28% 2019 bond, a couple of weeks ago. The last auction held on Friday the 27th of June saw the cut off coming in at 8.55% levels, with RBI having to devolve the auction on to the PDs given a long tail. The 8.27% 2020 bond is trading at just 3bps discount to the 7.28% 2019 bond at present. The market clearly overdid enthusiasm on the 8.27% 2020 bond.
Government bond yields moved up to one month highs on worries of weak monsoons, higher borrowings post budget on 10th July, Iraq tensions pushing up oil prices and an extremely flat yield curve. The five year benchmark bond, the 7.28% 2019 bond saw yields move up by 2bps week on week to close at 8.61% levels while the yield on the ten year benchmark bond, the 8.83% 2023 bond, moved up by 3bps to 8.75% levels. The newly issued 8.27% 2020 bond saw yields move up by 14bps with the RBI having to devolve 32% of the issue size of Rs 30 billion on to the primary dealers. The new 8.60% 2028 bond saw yields rise by 5bps to close at 8.68% levels.
Bond yields are likely to stay around current levels until the 10th of July when the new government will present its first budget. The pre budget noises of the government suggest that the fiscal deficit will be kept in check but whether a deficit of 4.5% of GDP is acceptable or not from February 2014 budgeted levels of 4.1% of GDP remains to be seen. If the deficit is pegged at 4.5% of GDP, the borrowing is likely to increase by around Rs 600 billion from budgeted levels of Rs 4570 billion.
Monsoons have been below normal in June and there are worries of drought in the country if rains do not pick up in July. The government is showing commitment to keeping down food prices and with record food grain production of 263 million tonnes last fiscal year, prices can be kept down with a smooth distribution policy. However temporary pressure on prices of vegetable is present during monsoons and this affects sentiment on inflation.
The ongoing tensions in Iraq are causing a rise in crude oil prices, which are trading at over one year highs. Oil prices in the longer term are unlikely to move much higher given that the world’s largest consumer of oil, the US, is expected to start exporting oil in a few years time. However in the short term, inflation expectations in India rise on higher global oil prices.
OIS market saw mixed movement in yields. One year OIS yields rose 2bps and five year OIS yields fell 1bps to close at levels of 8.36% and 7.93% respectively. The five over one OIS spread inverted by 3bps to close at negative 43bps levels. OIS yields are likely to stay ranged at current levels until the budget day on 10th July.
Corporate bond yields were largely unchanged week on week as the market chose to wait until the budget day to take directional calls on yields and spreads. Five and ten year AAA corporate bond yields closed unchanged at levels of 9.22% and 9.15% levels. Credit spreads fell with five year and ten year spreads falling by 4bps each to close at 20bps and 41bps levels respectively. Corporate bond yield and spread curve is inverted and this inversion will continue until liquidity eases in the system.
Liquidity eased last week as banks demand for funds fell in the reporting week. Bank borrowing from RBI was Rs 889 billion last week against a borrowing of Rs 965 billion seen in the week previous to last. Liquidity is likely to ease going forward as the government spends its surplus post budget.