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Debt Market

  • Jan 31, 2013

    Debt Commentary – May 2017

    In the month of May 2017, Government and Corporate bond yields eased due to the announcement of new 10year paper, lower CPI inflation for May 2017, GST implementation which is expected to be neutral to positive for Indian CPI inflation, expectation of Normal monsoon by Indian Metrological Department and Political uncertainty in the US markets. The old 10year (6.97 % 2026) which was trading at close to 7% levels due to the hawkish minutes by the MPC committee is now trading around 6.75% levels. The spread between liquid and illiquid papers compressed during this month and the 10 to 30year spread which was 80 basis points have now compressed to 70 basis points.

    With the introduction of the new 10year government security, sentiments changed in the bond markets as the cut off was 6.79%, lower than the market expectation of 6.83 % levels. The Debt markets changed its view on rate hikes after the announcement of CPI data for the month of April 2017. CPI inflation for the month of April was at 2.99% versus market expectation of 3.30%. Food inflation which normally starts moving up during summer showed a decline, with the year on year food inflation coming at 1.21%. Pulses prices declined by 15.94% on a year on year basis, vegetable prices showed a decline of 8.59%. More importantly, core CPI, the preferred gauge tracked by RBI is now at 4.30% lower than the 4.95% for the month of March 2017. The next CPI inflation reading for May 2017 should be below 2.5%, due to lower base effect. This should bring the first half CPI inflation in the range of 3 - 3.5% and the March ending CPI inflation to 4% levels a full 100 basis points lower than the projected CPI inflation by RBI in its monetary policy.

    FII Debt flows continued to remain strong with total FII flows in debt now at Rs. 70,435 crores for the current calendar year. FII invested Rs. 19,155 crores for the month of May 2017. Liquidity in the developed markets have increased due to quantitative easing done by Japan and ECB. This has led to spreads between high yield corporate bonds and U.S government securities reducing to 250 to 350 basis points compared with 700 to 800 basis points of last year. Due to this unattractive levels, FII are channelizing their investment into developing markets in search of yields. They are finding the developing markets attractive due to the high real interest rates. Real Interest rates is one year local Treasury bill rates reduced by one year expected local CPI inflation. Indian markets are attracting flows for FII as the real rates are above 200 to 250 basis points compared with real interest rates of negative 1% prevailing in the US markets. Even after hiking Fed Fund Rates in the coming years, the expected real rates could be zero or 50 basis points. RBI and the Indian government are committed to bring CPI inflation to 4 % in the medium term which should led to lower current account deficit. This should lead to rupee remaining relatively stable in the coming months due to higher real interest rates prevailing in India compared to developed markets.

    In the global markets, the 10year US yields have fallen to 2.15% as the non-farm payroll data has come at 1.38 Lakhs for the month of May 2017. Data for the month of March and April 2017 has been revised downwards cumulatively by 66,000. This brings the quarterly average non-farm payroll additions to 121,000 against the additions of 181,000 for the last 12 months. The labour force participation rate has also fallen to 62.7% from 62.90% of last month. This soft data has now put a question mark of 8 more hikes by the Fed Reserve as indicated by the dot plots given by the FOMC members. The chance of the third hike by the Federal Reserve during the current calendar year has reduced to 40 % as per the Fed Fund Implied Probability (source Bloomberg).

    Liquidity in the domestic market continued to be easy due to lower credit growth and RBI Intervention in the forex markets. The total excess liquidity is above 3 Lakh crores even after Cash Management Bills of Rs. 60,000 crores done by RBI. 3-month Certificate of Deposit rates are trading around 6.35-6.40% and NBFC Commercial Papers are trading at around 6.70- 6.90% levels. Corporate bonds yields are trading in the band of 40 to 50 basis points over comparable Government Securities. Corporate bonds have underperformed due to increase in issuances, increase in downgrades in good quality papers and other investment opportunities like state government securities having attractive yields.

    The fourth quarter GDP has come at 6.1%, which led to last year full year GDP growth rate to 7.1%. Investment demand has fallen to a 3 year low of 29.2% and consumer demand has remained weak. Lower CPI inflation in the coming months, uncertain global outlook and expectation of normal monsoon is leading to expectation of RBI softening its hawkish stance and lowering its inflation outlook to 4-4.5%. RBI policy Repo rates is 6.25% which is 2 to 2.25% higher than expected CPI inflation. This is leading to expectation of repo rate cut in the coming months. However, we feel RBI would like to see the spatial distribution of rainfall and the impact of GST before taking a call on cutting policy rates. Globally financial conditions are expected to tighten with Fed Reserve reducing its balance sheet from December 2017 onwards. ECB and Japan are also expected to reduce quantitative easing in the coming months. Given this background, RBI is expected to maintain its neutral stance while acknowledge the positives like CPI inflation being muted, global risk abating due to lower oil prices and a weak dollar. We expect the new 10year to remain in the range of 6.55% to 6.75 % in the current month.

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