Bond markets will start taking out any rate hike bets placed on bond yields. The higher than expected 50bps rate hike in the 26th July policy review coupled with global economic turmoil will force the RBI to adopt a wait and watch policy on inflation and economic growth. The RBI has started preparing the markets for a pause with RBI’s deputy governor Subir Gokran mentioning that global economic issues will play a role in future policy reviews.
The five year OIS (Overnight Index Swap) yield was the first to factor in softening of monetary policy stance from tight to neutral. The yield on the five year OIS has come off by 100bps from levels seen in May 2011. The sharp fall in five year OIS yields has resulted in the OIS yield curve inverting sharply with the five over one OIS spread trading at levels of a negative 70bps. The spread will now start flattening out as the market removes rate hike bets down the link.
Government bond yields are yet to reflect a rate hike pause. The government bond market has been hit by rate hikes and by government bond supply. The government finances are in red and the government is borrowing from the RBI to meet its funding needs. The RBI in turn is issuing Cash Management Bills (CMB) to reduce the government overdraft. The issue of CMB is over and above issue of treasury bills and dated government bonds. The market is seeing a good supply of government paper both at the short end of the curve and at the long end of the curve, and this is keeping yields pressured. One year treasury bill yields are trading at around 8.5% levels while ten year government bond yields are trading at around 8.32% levels. However, the market appetite for government paper is healthy as seen in the bids in the auctions. Bid to cover ratios are in the two to three times range.
Government bond yields should start trending down as the market factors in a pause in rate hikes. It is too early for the market to start factoring in an end to rate hikes as inflation is still trending at over 9.5% levels. The market will watch RBI’s tone in its policy review in September for cues on end to rate hikes. Until then bond yields while trending down will see volatility at lower levels of yields. The government bond yield curve will remain flat as long as overnight rates trade at repo rates of 8%.
The corporate bond yield curve is inverted with one year corporate bond rates trading higher than five and ten year corporate bond rates. The curve itself has fallen with yields across the curve coming off by around 25bps to 30bps over the last couple of months. Corporate bonds yields will trend down as rate hikes bets are taken off the table. The corporate bond yield curve will flatten as one year rates come off sharply on the back of RBI pausing on its rate hikes.
The US rating downgrade from AAA to AA+ by S&P will not affect Indian bond markets. FII’s have utilized the full limits on Indian government bonds and Indian corporate bonds (USD 25 billion), while the infra bond limit of USD 25 billion is unutilized. FII’s will not sell off Indian government or corporate debt on the back of US rating downgrade as India is rated BBB- which is just at investment grade by S&P and is unlikely to see further deterioration in rating soon.
Government bond auction
The government auctioned Rs 12,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 4000 crores, the 8.13% 2022 bond for Rs 5000 crores and the 8.28% 2027 bond for Rs 3000 crores. The cut offs came in at 8.30%, 8.39%, and 8.60% respectively. The government is scheduled to auction Rs 12,000 crores of bonds this week.
The government auctioned Rs 8000 crores of 49 days cash management bills last week. The cut off came in at 8.36%. The government is scheduled to auction Rs 6000 crores of 49 days cash management bills this week.