24 Jul 2022

Calm before storm for government securities

The government bonds are going to experience the impact of domestic factors such as high inflation, falling rupee, policy rate hikes, higher market borrowing and global factors such as global rate hikes, elevated global inflations in near future.

author dp
Team INRBonds
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Domestic Factors

  • Domestic inflation has remained at elevated levels. During June 22, it stood at 7.01% as compared to 7.04% in May 2022. High inflation has compelled RBI to hike policy rates with withdrawal of an accommodative stance. Wholesale price inflation stood at 15.18% in June 22.
  • In the first half of fiscal year 2022-23, the Union Government will borrow Rs 8450 billion, which is 56.52% of the total budgeted borrowing of Rs 14950 billion for the full fiscal year. It can be noted here that, during H1FY22, GOI had borrowed Rs 6713.57 billion. High market borrowing has caused domestic bond yields to remain at an uptrend. Given that the government is increasing its subsidy bill due to high energy prices, borrowing is likely to rise further.
  • In the scenario of high inflation and global rate hikes, rupee has breached the level of 80 denoting rapid depreciation against USD. The INR is trading at record lows with weakness on multiple fronts of capital outflows, rising trade deficit, high fiscal deficit and rising inflation.RBI is willing to reduce its fx reserves that are down by USD 60 billion, even further and this will cause liquidity to come off in the system.  
  • FPIs sold USD 29.36 billion from the domestic bond and equity market in 2022 so far.
  • The merchandise trade deficit for April-June 2022 stood at USD 70.80 Billion as against USD 31.42 Billion in April-June 2021, which is an increase of 125.34%.

International factors

  • US inflation has witnessed an uptrend. It rose to 9.1% in June 22 from 8.6% in May 22. To combat inflation, Fed hiked interest rates by 0.75% during its June 2022 policy-meeting, which is the most aggressive rate hike since 1994. The Fed also guided for either 50bps or 75bps rate hike in its upcoming policy-meeting.
  • Eurozone inflation soared to 8.6% in June 22 from 8.1% in the previous month and 1.9% in June 21 indicating the rapid uptrend since 1 year.
  • European Central Bank (ECB) delivered a 50basis points rate hike to tame inflation in its first rate increase since 2011.
  • ECB policymakers agreed to provide extra help for the 19-country currency bloc's more indebted nations - among them Italy - with a new bond purchase scheme intended to cap the rise in their borrowing costs and so limit financial fragmentation.

Government bonds, SDL and OIS yield movements

Last week, 10-year benchmark 6.54% 2032 paper yield came down by 3 bps to 7.41%. The 5-year benchmark bond, 6.79% 2027 yield decreased by 5 bps to 7.15%. 3-year benchmark 5.22% 2025 yield stood at 6.78%. Long-term paper, 6.99% 2051 yield declined by 1 bp to 7.73%.

The spread of 10-year bond over 5-year bond rose to 26 bps from 24 bps as compared to the previous week. The 15-year benchmark over 10-year benchmark spread rose to 20 bps from 18 bps while the 30-year benchmark over 10-year benchmark spread rose to 32 bps from 30 bps on a weekly basis.

Average 10-year SDL auction cut-off rose to 7.83% from 7.81% in previous week while spread came down to 40 bps from 42 bps.

On a weekly basis, 1-year OIS yield stood came down by 7 bps to 6.30% while the 5-year OIS yield came down by 6 bps to 6.51%.

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