Bond market is trading the INR not directly but indirectly through government bonds. The correlation between ten year government bond yield and INR has never been stronger. The yield on the 7.16% 2023 bond will rise if INR falls against the USD and the yield will fall if the INR strengthens against the USD. RBI has ensured that the government bond yield is tied to the INR.
The yield on the 7.16% 2023 bond rose 15bps week on week on the back of 3.5% fall in the INR. RBI left rates status quo in its policy review on the 30th of July but has indicated that the present tight liquidity policy will continue until the INR stabilizes. RBI may even resort to more monetary tightening if the INR falls further. However the central bank has maintained that its policy is still growth oriented and at an opportune time policy rates can be lowered.
Government bond yields will stay volatile as long as the INR is trending down.
Government finances are in deficit with the government spending all its cash surplus of over Rs 100,000 crores in the month of June. The government is resorting to WMA (Ways and Means Advances) from the RBI to fund its deficit. RBI in turn is auctioning Cash Management Bills (CMB) to reduce the government’s overdraft with the RBI. RBI auctioned 7 days CMBs worth Rs 3000 crores last week and is auctioning CMBs worth Rs 3000 crores this week. The cut off on the 7 days CMB auction last week was 10.36%.
Corporate bonds saw yields fall week on week as the market bought into absolute levels of yields. Five and ten year benchmark AAA corporate bond yields fell by 15bps and 10bps week on week to close at levels of 9.65% and 9.40% respectively. Five and ten year AAA credit spreads came off by 35bps and 30bps to close at 65bps and 90bps levels respectively. Corporate bond yields will stay steady at current levels and credit spreads will move on the back of movement in government bond yields.
OIS (Overnight Index Swaps) market saw one year OIS yields rise 4bps and five year OIS yields rise 14bps week on week to close at levels of 9.38% and 8.43% respectively. OIS yield curve will stay inverted as long as INR volatility persists.
Liquidity as measured by bids for the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids for repo averaging Rs 37,400 crores on a daily basis last week against an average of Rs 37,000 crores seen in the week previous to last. Bids for repo will stay around Rs 37,000 crores levels given RBI’s restriction on banks access to the repo window for funds. Banks can access the repo window up to 0.5% of their NDTL (Net Demand and Time Liabilities). Overnight money market rates traded at around 10% levels given RBI’s restriction on banks access to the LAF.