14 Nov 2022

Temporary respite for g-secs on US inflation data

US inflation data spurred a sharp rally in g-sec prices and OIS yields. However, this is temporary as structural issues for interest rates have a long way to go before being addressed.

author dp
Team INRBonds
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Ease in US inflation

Although US inflation fell to 7.7% in October from 8.2% in previous month, it is still much higher than the target average inflation of 2% as set by US Fed. Therefore, US Fed will continue to hike fund rate with a slower pace. After raising rates more sharply this year than at any time since the 1980s, including four straight 75-basis-point rate hikes that brought the policy rate to a 3.75%-4% range as of last week, a smooth transition of rate hikes may be possible in forthcoming meetings.

Higher Government borrowing

To mitigate adverse impact of corona pandemic, Union Government continues to do higher market borrowing. In the second half of fiscal year 2022-23, the Union Government will borrow Rs 5760 billion, which is 38.53% of the total budgeted borrowing of Rs 14950 billion for the full fiscal year. During FY23, GoI has borrowed Rs 8540 as gross amount from the market.

Shar fall in System Liquidity

Driven by tight monetary policy and absorption of excess liquidity by USD selling by the RBI, systemic liquidity has declined sharply in the last one year. As of 10th November 2022, systemic liquidity stood at a surplus of Rs 461.55 billion as compared to Rs 7980 billion of surplus as of 1st Nov 2021. The liquidity crunch has led to inversion of the g-sec yield curve.

Elevated domestic inflation

Despite previous rate hikes by RBI, consumer inflation remained at an elevated level which has become the major concern for the central bank. Consumer inflation rose to 7.41% in Sep 22 from 7% in the previous month.

Sharp Depreciation in rupee

In the current scenario of high inflation and global rate hikes, Indian currency depreciated significantly despite RBI’s policy rate hikes. Since last one year, USD INR exchange rate soared to Rs 82.29 from Rs 80.59.

Geo-political Issue

Russsia-Ukraine war has ignited crude price that has put direct impact on inflation.

Considering above factors such as higher inflation, global rate hikes, rupee depreciation, RBI is expected to continue rate hikes. G-sec yields will stay high with ups and downs on market reaction to new data.

Government bonds, SDL and OIS yield movements

10-year benchmark 7.26% 2032 yield declined by 16 bps to 7.31% while 6.54% 2032 yield decreased by 16 bps to 7.34%. The 5-year benchmark bond, 6.79% 2027 yield decreased by 27 bps to 7.17%. 3-year benchmark 5.22% 2025 yield decreased by 22 bps to 7.07%. Long-term paper, 6.99% 2051 yield decreased by 13 bps to 7.48%. 40-year paper, 7.40% 2062 yield decreased by 13 bps to 7.49%.

The spread of 10-year bond over 5-year bond rose to 14 bps from 3 bps as compared to the previous week. The 15-year benchmark over 10-year benchmark spread rose to 13 bps from 11 bps while the 30-year benchmark over 10-year benchmark spread increased to 17 bps from 14 bps on a weekly basis.

Average 10-year SDL auction cut-off rose to 7.83% from 7.82% in previous week while spread decreased to 40 bps from 42 bps.

On a weekly basis, 1-year OIS yield declined by 33 bps to 6.69% while the 5-year OIS yield decreased by 46 bps to 6.51%.

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