Bond yields are peaking out and post RBI mid quarter policy review on the 17th of June, yields are likely to stabilize at higher levels and then look to trend down on expectations of rate cuts in its July policy review. RBI is unlikely to cut rates on the 17th of June on the back of INR weakness but given weak growth outlook and falling inflation expectations, rate cut prospects look bright in July.
Government bond yields closed at one month highs last week as the markets took out bets of rate cuts by the RBI in its 17th June policy review. The ten year benchmark government bond, the 7.16% 2023 bond saw yields rise by 7bps week on week to close at 7.31% levels. The yield on the well traded 8.33% 2026 bond rose 8bps while the long bond the 8.30% 2042 bond saw yields rise by 14bps week on week.
Corporate bonds saw a sharp rise in yields with benchmark five and ten year AAA corporate bond yields rising by 20bps and 25bps respectively. Five and ten year credit spreads rose 7bps and 13bps to close last week at 65bps and 81bps respectively.
OIS (Overnight Index Swaps) yield curve rose with one and five year OIS yields rising by 3bps and 9bps week on week to close at 7.22% and 7.03% levels respectively.
RBI will release the mid quarter review of the annual monetary policy for 2013-14 at 11am on the 17th of June. The central bank will note the fall in inflation with WPI (Wholesale Price Index) and CPI (Consumer Price Index) for May 2013 coming in at 4.70% and 9.31% levels respectively. WPI and CPI are down from April levels of 4.89% and 9.39%.
RBI will highlight the weak trend in IIP (Index of Industrial Production) that grew by 2.2% in April against a growth rate of 2.5% seen in March. Negative growth in vehicle sales for the first two months of fiscal 2013-14 will be noted. Downward revision of global growth forecasts will be recognized.
The INR weakness will drive the policy in June. RBI was forced to intervene in the market as the INR threatened to cross the psychological Rs 59 level. The broad sell off of emerging market assets with currencies and equities of many South East Asian countries falling sharply over the last one month led to the INR weakness. A continuation of the sell off in emerging market assets will further pressurize the INR and this would require further currency market intervention by the RBI.
Liquidity is impacted when RBI intervenes to sell USD to protect the INR. RBI selling USD causes drain on INR liquidity. The first quarter advance tax outflows estimated at around Rs 32,000 crores will also cause liquidity to tighten. RBI may have to resort to OMOs (Open Market Operations) to ease system liquidity if bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI cross Rs 100,000 crores.
Bids for repo averaged Rs 65,000 crores on a daily basis last week against an average of Rs 61,000 crores seen in the week before last. Liquidity has eased over the last fortnight with bids from repo coming off from daily average levels of Rs 90,000 crores.