The depreciation of the Indian Rupee (INR) to record lows against the US Dollar has resulted in reduced hopes of policy rate cuts by the RBI in its July policy review. The Central Bank has placed the INR as a key factor in its policy stance after it maintained policy rates status quo in the policy review on the 17th of June.
Government bond yields rose sharply week on week as the INR threatened to drop below Rs 60 to the USD after the Fed outlined a time frame for withdrawing its USD 85 billion a month bond purchase program. The ten year benchmark bond the 7.16% 2023 bond saw yields rise by 12bps week on week to close at 7.43% levels. The well traded 8.33% 2026 bond saw yields rise by 12bps while the yield on the newly issued 7.28% 2019 bond rose by 22bps week on week. The bond market is worried about RBI’s reaction to a depreciating INR leading to a sell off in bonds. Government bonds will trade in a 10bps range at current levels in the coming weeks as the markets will be cautious on worries of further depreciation of the INR.
Corporate bond yields rose in sympathy with government bond yields though the pace of increase was lower. Five and ten year benchmark AAA corporate bond yields rose by 5bps each week on week to close at 8.35% and 8.30% levels respectively. Five and ten year AAA credit spreads fell by 7bps and 8bps week on week to close at 62bps and 73bps respectively. Credit spreads fell on the back of sticky corporate bond yields at higher levels. Corporate bond yields will stabilize at current levels given that the market sees absolute levels of yields as attractive.
OIS (Overnight Index Swap) markets saw the curve shift upwards with one and five year OIS yields moving up by 22bps and 24bps week on week respectively. One year OIS is trading at levels of 7.44% while five year OIS is trading at levels of 7.27%. The fact that OIS yields have moved over the repo level of 7.25% suggest that markets are taking out rate cut bets from the OIS curve.
Liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI averaged Rs 68,000 crores on a daily basis last week against an average of Rs 65,000 crores seen in the week before last. Liquidity has not been impacted by advance tax outflows of around Rs 35,000 crores as government spending brought the money back into the system. Liquidity at around Rs 70,000 crores deficit is well within RBI’s comfort zone and the central bank does not have to take any steps to ease system liquidity.
US treasury yields bore the brunt of the Fed’s time indication for withdrawal of bond purchases. US ten year treasury yields rose 40bps week on week as the markets factored in withdrawal of Fed’s bond purchase program and also the better prospects for the US economy in calendar 2014. US treasury yields should stabilize at current levels given that inflation expectations are trending down in the US. The Fed has lowered its core inflation forecast for 2014 even as it upped the growth forecast and sounded positive on unemployment rate coming off.