Asset prices have shot through the roof
Equities are at record highs, credit spreads at record lows, commodities at decade highs, real estate prices in US at record highs underscoring a potential asset price bubble. This bubble can grow and grow given that interest rates are at 0% in the developed world and central banks are in no hurry to raise rates. Liquidity too is substantial on balance sheet expansion of Fed and ECB.
The Fed Chair Jerome Powell in his Jackson Hole speech said that rates will stay low for a long while even as balance sheet expansion tapers off. This is fodder for risk assets and markets reacted accordingly.
What does this mean for India and RBI?
India has already seen equity markets at record highs while inflation is trending above RBI target levels. Capital flows are strong and RBI has been purchasing foreign currency to keep the INR from appreciating rapidly. Liquidity in the system is at levels of over Rs 7 trillion. RBI has also been buying government bonds to support the government borrowing program.
In the years just before the 2008 global credit crisis that saw financial markets collapse across the world, asset markets were at peaks and India saw high capital flows. At that time, there was no pandemic and RBI took steps to protect the system from global market collapse. However with the current pandemic, RBI is encouraging growth with low rates and high liquidity.
The question is, how sustainable is the rise in asset prices and will it cause a bubble burst. Should RBI be cautious and look to protect the system against a potential market collapse?
RBI should take baby steps in reigning in inflation and liquidity as a sign of prudence. Acting early can prevent a lot of stress later.
Government bonds, SDL and OIS yield movements
During last week, 6.10% 2031 yield rose by 2 bp to 6.25% while 5.85% 2030 yield came down by 1 bp to 6.24%. 5-year benchmark bond, 5.63% 2026 yield declined by 1 bp to 5.68%. 6.64% 2035 yield declined by 2 bps to 6.81%. 6.57% 2033 yield declined by 1 bp to 6.64%. Long-term paper, 7.16% 2050 yield decreased by 5 bps to 7.13%.
The spread of 10-year bond over 5-year bond rose to 57 bps from 54 bps in previous week. The 15-year benchmark over 10-year benchmark spread came down by 3 bps to 39 bp, while 30-year benchmark over 10-year benchmark spread declined by 8 bps to 78 bps on weekly basis.
Average 10-year SDL auction cut-off rose to 6.99% from 6.97% in previous week while spread remained unchanged at 74 bps.
On weekly basis, 1-year OIS yield rose by 1 bp to 3.89% while 5-year OIS yield increased by 1 bp to 5.17%.
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