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Debt Market

  • Jul 12, 2017

    Debt Commentary – June 2017

    30-Jun-17 31-May-17 Change (bps)
    10 Year Benchmark Yield (s.a) 6.51% 6.66% -15
    10 Year AAA (PSU) (ann) 7.43% 7.65% -22
    5 Year AAA (PSU) (ann) 7.32% 7.44% -12
    3 Month T Bill 6.29% 6.28% 1
    3 Month CD 6.33% 6.35% -2
    12 Month CD 6.63% 6.73% -10
    10 Year AAA Spread 0.81% 0.88% -7
    5 Year AAA Spread 0.70% 0.67% 3

    Sovereign bond market remained volatile throughout the month after witnessing a massive rally on the back of increasing expectation of rate cut after 2nd Bi-monthly monetary policy. Globally, bond yields remained volatile with US 10-year trading in the range of 2.13-2.30 and closing the period at 2.30. For the period under review, the 10-year benchmark yield softened by 15 bps to close at 6.51%. The corporate bonds also followed G-Sec, with 10-year AAA yields down by 22 bps, while the 5-year AAA bond yields were down by 12 bps. Money market instruments at the shorter end of the curve saw 3-month treasury bill harden by 1 bps, 3-month CD yield softened by 2 bps and 1 year CD yield eased by 10 bps.

    RBI in its Second Bi-monthly monetary policy kept key policy rates unchanged. In an unexpected move, RBI decided to reduce the SLR from 20.5 per cent of NDTL to 20.0 per cent of NDTL. RBI has recognized modest pace of growth in global economy, improvement in international financial markets, lower estimate of GVA domestically, and improving economic indicators domestically. On inflation front, RBI has recognized sharp broad-based fall in CPI because lower vegetable, cereal, pulses and fuel prices. RBI has also acknowledged a fall in household inflation expectations. On the liquidity side, RBI has noted the fall in currency in circulation and over-night call rates remaining closer to operating target. RBI has indicated a broader accommodative policy move if inflation trajectory continues to remain benign and below their earlier projections.

    On the macroeconomic data released during the period, May CPI fell sharply to 2.2% from 3% in April as food prices slipped into deflation for the first time since 2001, due to improved supply (pulses, vegetables) and lower global prices (edible oils). Food prices fell by 1.0% YoY in May from 0.6% in April with vegetables and pulses remaining in deflation at -13.4% and -19.5%, respectively. Core CPI inflation eased to 4.2% YoY in May from 4.4% in April.

    WPI inflation moderated sharply to 2.2% YoY in May from 3.9% in April, significantly below market expectations. Food, crude petroleum and fuel inflation fell sharply, while manufactured WPI inflation (ex-food) picked up. Food price inflation (primary + manufactured) moderated to 0.1% YoY in May from 2.9% in April, with primary food prices slipping into deflation for the first time in 21 months. The moderation was quite broad-based, with prices of cereals, pulses, fruits & vegetables and eggs, meat & fish falling sequentially. IIP (Index of Industrial Production) moderated to 3.1% YoY in April from an upward revision of 3.8% in March. Consumer non-durables and infrastructure output growth saw a decent uptick, while overall industrial cycle appears to have troughed.

    FII flows continue to remain strong with Rs. 25,685 crores invested in government securities and corporate bonds. However global markets have turned negative after ECB president Draghi statement on central banks reducing the risk premia of deflationary trade as the euro zone in the reflationary trade led to spike in bond yields even though the ECB President maintained accommodative monetary policy stance will continue. The 10 year German bonds yields moved by 15 basis points and the US ten year yields moved to 2.30 % levels from 2.15 %.

    RBI has announced an OMO of Rs 10,000 crores to drain out liquidity from the banking system. The total liquidity has increased from 2.8 Trillion to 3.6 Trillion Rupees due to government spending and RBI intervention in the forex markets. There is also a redemption of Rs 55,000 crores on July 10. The supply of state government papers for the quarter July to September is Rs 98,000 crores to Rs 1,04,500 crores as per the Indicative borrowing calendar announced by RBI.

    The CPI inflation is expected to print in the range of 1.5 to 1.8 % for the month of June due to high base effect, destocking by industry due to implementation of GST and food prices continuing to remain stable. We believe RBI might move towards accommodation and lowering of policy rates provided incoming data trend continues and doesn't abruptly spikes on the other side. We believe there is space for 25bps rate cut in near future and further scope of rate cuts to remain data dependent. We expect 10-year G-sec yield to trade range-bound in near term, within a band of 6.45%-6.65%. We expect liquidity to remain comfortable and in surplus mode for a few months going ahead which will limit upside in short-term rates.

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