The 25bps repo rate hike effected by the RBI in its 20th September 2013 monetary policy review did not go down well with the market that was expecting status quo on the repo rate. Bond yields rose across the government bond yield curve with five, ten and seventeen year benchmark bond yields rising by 30bps to 35bps on the back of the negative surprise from RBI. Bond yields at the long end of the curve will find a range at higher levels as the market absorbs the repo rate hike. The ten year benchmark bond, the 7.16% 2023 bond will see yields move in a 8.50% to 8.75% range with factors such as auction cut offs, inflation data and INR movements determining the yields.
The short end of the yield curve will see yields coming off sharply as the RBI recalibrates policy to make the Repo rate the operational policy rate. At present the operational policy rate is the MSF (Marginal Standing Facility) rate, which is 200bps over the repo rate. MSF rate was lowered by 75bps in the policy review from levels of 10.25% to 9.5%, while the repo rate was hiked from levels of 7.25% to levels of 7.5%.
RBI has committed itself to bringing down the MSF rate to 100bps over repo rate over the short term, provided global markets stay stable and INR volatility comes off. RBI will also remove the restrictions on banks access to the LAF (Liquidity Adjustment Facility) that is now fixed at 0.5% of NDTL (Net demand and Time Liabilities). Once the restriction on banks access to LAF is removed, the repo rate will become the operational rate.
Overnight money market rates that will trend at MSF rate of 9.5% will come down to repo rate levels of 7.5%. The fall of 200bps in overnight rates will pull down yields at the short end of the yield curve. 91 day T-bill yields that are trading at close to 10% levels and 364 day T-bill yields that are trading at levels of 9.45% will see yields come off sharply. Government bonds at the five, six and seven year segments of the yield curve will also see yields come off from levels of 8.80% to 8.90%.
Certificate of Deposit (CD) yields fell by 50bps post the RBI policy on expectations of fall in overnight money market rates. One year CD yields will come off from levels of 9.70% once the repo becomes the operational rate. Two, three and five year benchmark AAA corporate bond yields too will see yields coming off from levels of 9.7% to 9.90%.
OIS (Overnight Index Swaps) market will see the yield curve flattening as one year OIS yields come off from levels of 8.8% while five year OIS yields stay sticky or even trend higher from levels of 8.3%.
Liquidity outlook is improving on the back of the expected inflows through the FCNR B swap window that the RBI has opened for banks. Banks are swapping USD for INR at 3.5% per annum and inflows have cross USD 1.5 billion over the last couple of weeks. Inflows are expected at around USD 15 billion to USD 20 billion and INR liquidity ease by Rs 90,000 crores to Rs 120,000 crores. Easing system liquidity is positive for yields at the short end of the curve.
Liquidity eased last week as banks demand for funds came off in the reporting week. Borrowing under MSF (Marginal Standing Facility) fell by Rs 36,000 crores last week. MSF borrowing was Rs 81,000 crores as of 19th September against levels of Rs 116,000 crores seen on the 13th of September. Repo borrowing was flat at around Rs 39,400 crores in the LAF (Liquidity Adjustment Facility) auctions of the RBI. Liquidity will tighten this week as banks demand for funds increase due to half year closing of accounts on 30th September.