The benchmark ten year government bond, the 7.16% 2023 bond saw yields touch 9.10% last week, the highest levels since 19th August 2013, before closing at 9.03% levels. The yield on the bond rose 4bps week on week. Ten year bond yields have risen by 50bps since the RBI hiked the repo rate by 25bps on the 29th of October 2013.
The rise in bond yields is largely due to two factors a) Inflation trending higher and b) Worries of Fed stopping bond purchases leading to a weakening INR. The outlook for both factors are turning positive with inflation looking to come off on lower vegetable prices and the incoming Fed chairman Janet Yellen reiterating her support for bond purchases. Ten year yields at 9.03% levels are toppish and will start trending down going forward.
RBI is also doing its bit by talking down the markets (in terms of bond yields). The RBI Governor, Dr. Raghuram Rajan forecast that the CAD (Current Account Deficit) is likely to end this fiscal 30% lower than the last fiscal and that the country is well prepared for the Fed withdrawing bond purchases. RBI has received over USD 17 billion of inflows through the FCNR B route after opening the swap window in September. RBI will also provide USD directly to oil companies and this puts paid to fears of INR falling once the swap window for oil companies close.
The central bank is holding an Rs 8000 crores OMO (Open Market Operation) purchase auction on the 18th of November to alleviate bond market concerns on supply, liquidity, inflation and the INR.
Inflation as measured by the CPI (Consumer Price Index) and WPI (Wholesale Price Index) printed at 10.09% and 7% respectively for the month of October 2013. Vegetable prices that rose 45% year on year drove both the indices higher. Markets will be hopeful of vegetable prices coming off sharply as the government removes supply bottlenecks and this will bring down inflation expectations going forward.
The incoming Fed chairman Janet Yellen commented last week that the US economy requires further push for unemployment rates to come off from levels of 7.3% seen in October 2013. Fed is likely to maintain its USD 85 billion a month bond purchase program until first quarter 2014 before taking a call on tapering off asset purchases. Fed maintaining its asset purchases is good for the INR as there will not be pressure on FIIs to take money out of INR bonds and equities.
Corporate bond yields rose last week with benchmark five and ten year AAA corporate bond yields rising by 5bps each to close at 9.75% and 9.70% levels respectively. Five and ten year AAA credit spreads closed at 78bps and 48bps levels respectively reflecting the steeper government bond yield curve. Five year corporate bond yields can come off on the back of improved market sentiments.
OIS (Overnight Index Swaps) market saw one and five year OIS yields rise by 14bps each week on week to close at 8.62% and 8.50% levels respectively. OIS yields rose on expectations of repo rate hike by the RBI post higher inflation numbers. OIS yields will fall on better bond market sentiments going forward.
The system is borrowing around Rs 90,500 crores from the RBI. Bids for repo in the LAF (Liquidity Adjustment Facility) averaged Rs 40,400 crores on a daily basis last week. Term repo outstanding is Rs 38,500 crores (cut off was at 8.30% in the 14 day term repo auction). MSF borrowing was Rs 11600 crores (as of 13th November 2013). Overnight rates closed at 8.6% levels last week and are likely to come off as liquidity eases on the back of bond purchases by the RBI.