Government bond yields are set for a downward trend in the coming days. The ten year benchmark bond, the 7.80% 2021 bond is trading at levels of 8.27% and with factors turning positive for bond yields, the yield on the bond will conclusively break the lows of 8.15% seen in the week before last. The corporate bond yield curve will steepen while the OIS curve will flatten on the back of government bond yields coming off.
The bond markets have seen the worst and there are better days ahead. The factors that drove bond yields to multiyear highs are abating and are in fact turning positive for bonds. Inflation, rate hikes, bond auctions and government finances took up bond yields over the most part of this fiscal 2011-12 and these factors look to be turning around. Inflation as measured by the WPI (Wholesale Price Index) came in at 9.22% for the month of July 2011. Inflation for July at 9.22% was against the 9.44% inflation for June and the revised 9.59% for May. The numbers are likely to be revised upwards going by the past trend, but the magnitude of revisions will be moderate. Inflation is likely to print below 9.5% levels of August 2011 and going by the current weakness in commodity markets, inflation expectations are coming off. Global crude oil prices have eased by almost 15% from peaks seen during this year on the back of weak economic growth sentiments. Global growth forecasts have been revised downwards post the US debt downgrade with Morgan Stanly revising downwards world GDP growth by 30bps and 70bps for calendar years 2011 and 2012 respectively. Inflation is slowly peaking out and this will play a large role in further RBI policy rate hike expectations coming off.
The RBI will hold on to policy rates in its September 2011 policy review. The minutes of the TAC (Technical Advisory Committee) meet on monetary policy suggested that the majority of the members of the panel were not in favor of a 50bps rate hike. The RBI governor had his way on the rate hike of 50bps but given inflation peaking off, global growth coming off and prevailing weak sentiments in the capital markets, the RBI is likely to maintain rates status quo in the coming policy reviews.
Government borrowing is in its last stages for the first half of this fiscal. The government has three more auctions to go before its finishes its borrowing for the first half of fiscal 2011-12. The market was facing weekly government bond auctions of Rs 12,000 crores over the last five months and the tapering of these auctions will give the market space to execute its interest rate views. Government finances are looking better with government’s overdraft with the RBI coming down from Rs 50,000 crores to Rs 16,000 crores as of week ended 12th August 2011. The market will not worry about unscheduled auctions in the near future.
The sharp fall in risk assets globally and the subsequent flight to safety will filter down to bond yields in India. The concerns on global growth and the lack of policy response has led to a 12% to 15% fall in equity indices globally over the last one month. Ten year benchmark US treasury yields have fallen by 80bps in the same period. Global markets are factoring in a period of slow growth and low inflation and this scenario is positive for bond yields in India.
The corporate bond curve will shift down with a steepening bias in the coming weeks. One year, three year, five year and ten year AAA benchmark corporate bond yields are trading at levels of 9.60%, 9.40%. 9.40% and 9.39% respectively. A pause in rate hike by the RBI will take the one and three year bond yields sharply down leading to a steepening of the corporate bond curve.
The OIS (Overnight Index Swap) curve is hugely inverted with the spread between the five year OIS and the one year OIS yield at a negative 92bps. Five year OIS yields have largely discounted fall in interest rates while the one year OIS is yet to fully factor in an easier interest rates regime down the line. The spread between the five year and one year OIS yields will come off as the market start looking at a more benign period for interest rates.
Government bond auction
The government auctioned Rs 10,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 3000 crores, the 8.08% 2022 bond for Rs 4000 crores and the 8.28% 2022 bond for Rs 3000 crores. The cut offs came in at 8.29%, 8.41%, and 8.60% respectively. The government is scheduled to auction Rs 11,000 crores of bonds this week.