Debt Commentary – September 2016
| ||30-09-2016 ||31-Aug-16 ||Change (bps) |
|10 Year Benchmark Yield (s.a)
|10 Year AAA (PSU) (ann)
|5 Year AAA (PSU) (ann)
|3 Month T Bill
|3 Month CD
|12 Month CD
|10 Year AAA Spread
|5 Year AAA Spread
The sovereign bonds continued their bullish momentum this month as well, helped by a favorable global and domestic factors. On the domestic front, the weak growth momentum as reflected in lower than expected GDP & IIP number and a steep fall in retail inflation from 6% to 5% revived the hopes of rate cut in the upcoming October policy meet. Globally, central bankers continued to maintain their dovish stance so as to push up inflation and bolster economic growth, greatly boosting the market sentiments. The Bank of Japan reiterated that it stays committed to bring inflation closer to its target by way of accommodative monetary stance. The US Fed while maintaining status quo on rates in its September Policy, remained fairly dovish as seen in its altered (downward) FFR/economic projections. For the period under review, the 10 year benchmark yield (old) eased by around 15 bps to close at 6.96%, while the new 10 year bond closed at 6.81%. The corporate bond yields too followed the bullish momentum in the underlying, with 10 year AAA yield easing by 19 bps, while the 5 year counterpart easing by around 6 bps. The yields on the money market instruments at the shorter end eased significantly, on easy liquidity and expectation of policy rate cut by in the forthcoming policy meet.
On the macro economic data released during the period, the CPI inflation moderated sharply to 5.05% y-o-y from 6.1% in July, marginally below consensus expectations. The decline was driven by a combination of lower food prices and favorable base effects. Food price inflation fell sharply to 5.9% y-o-y from a 23-month high of 8.4% in July, led by a sharp fall in prices of vegetables (-3.7%), pulses (-1.0%) and meat & fish (-1.3%). Meanwhile, core CPI moved up marginally to 4.7%, from 4.6% in July. We expect the headline CPI inflation to moderate to below 5% in coming months owing to base effects, but we expect it to revert back towards the RBI’s target of 5% by March 2017. However, potential increase in house rent allowances and GST implementation could push headline inflation above the RBI’s 4%+/-2% target in 2017.
The WPI inflation rose to a two-year high of 3.7% y-o-y in August from 3.5% in July, below consensus. The jump in year-on-year inflation is largely base-effect driven and actual momentum is weaker: WPI inflation fell 0.2% m-o-m in August, much lower than the preceding six-month average rise of 0.6%. Weaker momentum was largely due to the recent fall in commodity prices, which led to a sharp month-on-month decline in fuel and metal prices. Food inflation did moderate, consistent with the trend seen in CPI inflation. Looking ahead, with base effects remaining adverse, we expect year-on-year WPI inflation to rise until March 2017. This will result in a shrinking of the gap between CPI and WPI.
The industrial output growth fell to -2.4% y-o-y in July from 2.0% in June, significantly below expectations. A contraction in capital goods and weak supply side (mining, electricity) weighed on industrial output growth. The volatile cables and rubber insulated products category was the key culprit, dragging IP growth down by 4.2%. Both mining and electricity output growth slowed sharply in July, indicating that a sustained pick-up on the supply side is yet to materialise. Manufacturing growth fell to -3.4% y-o-y (vs +0.7% in July), likely due to weak investment and external demand. The divergence between consumer and capital goods growth continued, although both weakened relative to July. Capital goods contracted for the ninth consecutive month, dragged down by weak private sector investment and a slow start to the public capex cycle so far this year. Meanwhile, consumer durables edged up slightly, although they appear to have broken lower to the 5-6% growth range since May, compared with the double-digit growth seen earlier (June 2015-April 2016). Consumer non-durables contracted yet again, indicating that an improvement in rural demand on the back of higher agriculture production is yet to materialise.
The steep fall in headline CPI inflation (1% MoM), muted rise in core inflation, improved monsoon, higher YoY sowing and benign international commodity prices have strengthened the case for further policy easing. We now expect a 25bps rate cut to materialize in the upcoming policy and a cumulative of 50bps cut in FY17 as inflation is expected to stay on the glide path (5% target by Mar’17). While the market has already discounted a 25 bps rate cut markets, it will be keenly watching RBI’s forward guidance & the new MPC’s view on inflation trajectory. Even in the absence of a rate action, yields are now unlikely to witness any significant upward pressure given that economic fundamentals remain favorable & inflation benign.