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Debt Market

Debt Commentary – July 2018

31-Jul-18 30-Jun-18
Change (bps)
10 Year Benchmark Yield (s.a) 7.77% 7.90% -13
10 Year AAA (PSU) (ann) 8.53% 8.61% -8
5 Year AAA (PSU) (ann) 8.57% 8.65% -8
3 Year AAA (PSU) (ann)
8.52% 8.57% -5
1 Year AAA (PSU) (ann)
8.32% 8.30% 2
3 Month T Bill 6.69% 6.46% 23
3 Month CD 7.05% 6.93% 12
6 Month CD 7.48% 7.56% -8
9 Month CD 7.60% 7.73% -13
12 Month CD 8.03% 8.07% -4
10 Year AAA Spread 0.61% 0.55% 6
5 Year AAA Spread 0.65% 0.59% 6

 

Sovereign bond market remained volatile throughout the month on the back of higher inflation, MSP announcement and hardening of global bond yields. Globally bond yields hardened during the month as US yields moved up. US Treasuries hardened to 2.96% compared to 2.85% at the beginning of the period.  India 10-year G-Sec remained volatile throughout the month and closed the month at 7.77% after hitting a mid-month high of 7.91% compared to 7.90% at the beginning of the month. Corporate bonds also followed the suite with 10-year and 5-year corporate bond yields ending the period at 8.53% and 8.57% both down by 8 bps respectively over previous month close. Money market instruments at the shorter end of the curve saw 3-month Treasury bill hardening by 23 bps and 3-month CD yields hardened by 12 bps while 12-month CD yields eased by 4 bps. FPI activity saw net inflows of 176 crores for the month of July 2018 compared to an outflow of 10,593 crores in the month of June 2018. Cumulatively, FPI outflows from debt market for FYTD stood at Rs. 43,264 crs. Indian Rupee traded range bound throughout the month ending the period at 68.55 compared to 68.47 at the beginning of the period and 65.12 at the beginning of financial year.

Crude oil prices remained volatile during the month hitting a low of 71.44 on the back of reopening of Libyan ports and amid hopes that Iran will still export some crude despite US sanctions and reports of lower global demand for crude because of sluggish growth. Brent Spot closed the month at 74.25 compared to 79.44 at the beginning of the period. 

On the macroeconomic data released during the period, June headline inflation rose lower-than-expected 5% from 4.9% in May, but core inflation picked up to 6.6% from 6.3%. The (lower) surprise was mainly in food price inflation, which moderated to 2.9% y-o-y in June vs 3.1% in May, led largely by a sequential moderation in fruits and the usual glut-led deflationary pressure in pulses. The pick-up in core inflation is partly owing to base effects, but the sequential momentum remains elevated. Industrial production (IP) growth moderated to 3.2% in May from 4.8% in April, below expectations. On a seasonally adjusted basis, IP fell 0.4% versus a 0.7% fall in April, implying sequential weakness. On a 3-month moving average basis, IP growth moderated to 4.2% in May from its peak in January (7.8%), led by a moderation in both capital and consumer goods output growth, indicating the overall industrial trend is weakening.

RBI in the Third Bi-monthly Monetary policy hiked the Repo rate by 25 bps to 6.50% but maintained stance unchanged at “neutral”. The 6 member Monetary Policy Committee (MPC) had a sole dissenter in the Committee and vote for hike was 5-1. The decision was prompted by elevated core inflation and as headline inflation remained above the medium-term target of 4% amid an output gap that has “virtually closed”. RBI revised downward its Q2-2018 inflation expectations to 4.6% and maintained H2 inflation forecasts of 4.8% and 5.0% in Q1-FY2020. RBI said that risks to inflation are evenly balanced. The RBI has delivered back-to-back hikes while maintaining a neutral stance. RBI’s reluctance to shift to a ‘withdrawal of accommodation’ stance suggests that it is not convinced about inflation outlook going forward and would like to be in wait & watch mode. Now, we believe that market will take cues from global developments (Developed Market yields and Crude prices) and liquidity (for OMO announcements) as risk of stance change in August policy is out of the way.

Systemic liquidity during the month of June hit a low of negative 73,700 crs before closing the period at negative 27,600 crs versus positive 8,300 crs at the beginning of the month. RBI announced Cash Management Bills (CMBs) of 20,000 crs during the month to meet the government’s temporary shortfall. RBI also conducted OMO purchase of 10,000 crs during the month to provide durable liquidity.

Going forward, we expect RBI to stay on hold for October policy. However, we expect RBI to hike rate once more by 25 bps in FY19 if following risks materialize – hike in federal funds rate, depreciating rupee, increasing momentum in core inflation continues, stress on rupee persists, crude oil prices trend upwards and FPI outflows. OIS curve is already pricing in one more hike with 1-year OIS at 6.90% with a current repo rate of 6.50%. We expect 10-year G-sec yield to trade range-bound in near term, within a band of 7.60%-8.00% and 10-year Corporate bonds to trade in a range of 8.45%-8.75%. We expect the short-term rates to remain range bound due to adequate liquidity made available due to RBI dividend payment to the government and month end government spending.

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