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Market Commentary

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Debt Market

Debt Commentary – May 2018

31-May-18 30-Apr-18
Change (bps)
10 Year Benchmark Yield (s.a) 7.83% 7.77% 6
10 Year AAA (PSU) (ann) 8.55% 8.41% 14
5 Year AAA (PSU) (ann) 8.58% 8.36% 22
3 Month T Bill 6.40% 6.19% 21
3 Month CD 7.70% 7.05% 65
12 Month CD 8.08% 7.58% 50
10 Year AAA Spread 0.57% 0.49% 8
5 Year AAA Spread 0.60% 0.44% 16


Sovereign bond market remained under pressure during the month on the back of rising crude oil prices, depreciation rupee and increasing core inflation momentum. RBI announced Open market operations purchase of Government securities at Face value of Rs 10,000 Crores, when 10-year yields moved above 7.90 % levels. This capped the rise in Government bond yields. Subsequently, Government 10-year yield became range bound in the band of 7.70 %- 7.85 %.

Globally bond yields remained volatile as Global Economic Growth and Inflation moved up. In the US, the average non-farm payroll additions for this calendar year is 200,000 and the unemployment rate has come down to 3.9 % versus 4.4 % levels. US CPI inflation for the month of April touched 2% due to higher energy prices and core CPI, which exclude energy and food prices, was at 1.8 %. This increases expectation of more than 3 rate hikes by US Fed in the CY18. US 10-year note touched a high of 3.11 % before closing at 2.86% versus 2.95% at the beginning of the month. US Federal Reserve Chairman stated its was to see CPI inflation sustaining at 2% levels after years of undershooting of CPI targets.

In the Indian context, the 10-year G-Sec yields hardened by 6 bps and closed at 7.83 %. Corporate bonds also followed suite with 10-year and 5-year corporate bond yields hardening by 14 bps and 22 bps respectively. Money market instruments at the shorter end of the curve saw 3-month Treasury bill hardening by 21 bps and 3-month and 12-month CD yields rose by 65 bps and 50 bps respectively. Net FPI outflows in Indian debt market stood at Rs. 19,654 crores for the month of May 2018.

Crude oil prices firmed up during the month due to falling Venezuelan output, due to rising political tensions. Downside risks to Iranian crude output and higher compliance by OPEC & non-OPEC on production cut led to a spike in crude prices. Brent Spot hit a high of 79.8 before closing at 77.6 from 75.17 per barrel at the beginning of the period. 

On the macroeconomic data released during the period, April CPI inflation surprised on the higher side at 4.58% versus 4.30% for March. The rise in CPI inflation was mainly due to increasing momentum in core inflation. Core inflation jumped by 0.7% MoM pushing headline core inflation to the highest in this series at 5.84% YoY. Rise in core inflation was more broad based in the month of April with upside in Education, Health, Recreation, Household goods, Clothing and Services. IIP for the month of March moderated to 4.4% YoY from 7.1% YoY in February hitting a 5-month low. Deceleration in industrial growth was largely because of slowing momentum in core infrastructure, exports and automobile production.

Systemic liquidity tightened during the month of May due to increasing currency in circulation. Short term rates spiked due to skewed liquidity condition wherein, PCA banks flushed with liquidity stopped lending due to capital constraints and deployed money in reverse repo. Whereas non-PCA banks were facing liquidity crunch. This led to increased supply by non-PCA banks and NBFCs to meet the increasing demand for credit. Banking system liquidity hit a low of negative Rs 40,900 crs during the month before closing the month at positive Rs 1,000 crs versus positive Rs 35,584 crs at the beginning of the month.

Going forward, we expect the RBI to stay on hold in June monetary policy with a change in stance to withdrawal of monetary accommodation. Higher Oil Prices (RBI has taken Indian crude at 68 dollars per barrel versus 78 prevailing at present), depreciating rupee due to portfolio outflows, emerging markets selloff, may induce RBI to prepone repo rate hike. We expect a total of 50 bps hike by RBI in FY19.

We expect 10-year G-sec yield to trade range-bound in near term, within a band of 7.75%-7.95% and 10-year Corporate bonds to trade in a range of 8.50%-8.70%. Short term rates which have increased due to tightened liquidity conditions should come down going forward as RBI may infuse liquidity in the system through Open Market Purchase of Government Securities. RBI is also expected to take delivery of forward purchase of dollars, which will add liquidity in the banking system.

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