RBI is expected to hike rates in its October policy meet and is selling USD continuously in the face of a Fed and ECB rate hike onslaught. This is causing a huge liquidity crunch, which coupled with banks Incremental Credit Deposit Ratio running at well over 100%, will cause the gsec yield curve to invert with 1 to 5 year gsec yields at higher levels than the 10 year gsec yield.
OIS yield curve jumped last week on liquidity issues and is frontrunning a curve inversion. This will filter into corporate bond markets as well.
In the current scenario of high inflation and global rate hikes, Indian currency depreciated significantly. Since last one year, USD INR exchange rate soared to Rs 79.65 from Rs 73.69. Therefore, RBI has conducted sell buy swap operation worth USD 10 billion in March and April of USD INR pair to protect from rapid depreciation of Indian rupee. It is expected the central bank will continue buying Indian rupee and selling of USD to protect domestic currency value.
Domestic system liquidity has come down to Rs 482.07 billion (as of 15th Sep 2022) from Rs 8574.45 billion as of 1st Sep 2021. During H1FY22, RBI conducted GSAP and OMO to infuse liquidity in the system to help recover the economy from impact of covid pandemic, while keeping policy repo rate at an ultra-low level. Consequently, it led to high inflation that went beyond the upper limit of inflation pegged by the central bank (6%).
Domestic Inflation- India’s consumer inflation rose to 7% in Ag 2022 from 6.71% in July 2022 driven by higher food prices. Food inflation stood at 7.62% in August 2022.
Government bonds, SDL and OIS yield movements
New 10-year benchmark 7.26% 2032 yield rose by 10 bps to 7.23% while 6.54% 2032 yield increased by 10 bps to 7.27%. The 5-year benchmark bond, 6.79% 2027 yield rose by 21 bps to 7.19%. 3-year benchmark 5.22% 2025 yield rose by 21 bps to 7.03%. Long-term paper, 6.99% 2051 yield declined by 4 bps to 7.31%.
The spread of 10-year bond over 5-year bond declined to 4 bps from 13 bps as compared to the previous week. The 15-year benchmark over 10-year benchmark spread decreased to 13 bps from 20 bps while the 30-year benchmark over 10-year benchmark spread decreased to 13 bps from 24 bps on a weekly basis.
Average 10-year SDL auction cut-off declined to 7.45% from 7.53% in previous week while spread rose to 35 bps from 34 bps.
On a weekly basis, 1-year OIS yield soared by 25 bps to 6.61% while the 5-year OIS yield came down by 30 bps to 6.61%.
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