Fed taper and RBI October policy
Fed in its FOMC meet last week indicated a quicker than expected tapering of bond purchases and rate hikes. Economic recovery with inflation prompted Fed to start normalising policy sooner than expected. US treasury yields rose while gsec yields followed in sympathy.
RBI is meeting in October for its bi-monthly policy review and the question bond market will ask is whether RBI may be proactive in preventing any market instability on Fed taper. In 2013, the market reaction to Fed taper was severe and jolted the RBI.
Indian economy is looking up with equity markets at record highs factoring in good earnings growth. Inflation too is at higher levels, even after trending down to 5.4% from well over 6% levels. Inflation expectations are high given that demand is picking up at a faster pace than supply, prompting fresh capex plans. HDFC Bank is raising funds through infra bonds indicating capex demand.
RBI may look to offer guidance on its policy normalisation path and could signal rate hikes starting end 2021 or early 2022. Policy normalisation could start with sucking out liquidity from the system. These two factors will contribute to short end yields rising faster than long end yield, flatting an yield curve that will anyway shift higher.
Government bonds, SDL and OIS yield movements
During last week, 6.10% 2031 yield rose by 1 bps to 6.18% while 5.85% 2030 yield increased by 2 bps to 6.18%. 5-year benchmark bond, 5.63% 2026 yield rose by 3 bps to 5.65%. 6.64% 2035 yield gained 3 bps to 6.69%. 6.57% 2033 yield remained unchanged at 6.57%. Long-term paper, 7.16% 2050 yield gained 1 bps to 6.94%
The spread of 10-year bond over 5-year bond came down to 53 bps from 55 bps in previous week. The 15-year benchmark over 10-year benchmark spread declined by 1 bps to 39 bps, while 30-year benchmark over 10-year benchmark spread decreased by 2 bps to 71 bps on weekly basis.
Average 10-year SDL auction cut-off declined to 6.80% from 6.87% in previous week while spread rose to 68 bps from 67 bps (on 21st Sep, benchmark yield stood at 6.12%) in previous week.
On weekly basis, 1-year OIS yield rose by 6 bps 3.92% while 5-year OIS yield increased by 7 bps to 5.24%.
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