Bond yields in India will follow US bond yields on its way down sooner than later. The fact that growth is the concern globally will filter into commodity prices leading to a fall in inflation expectations. China, a big commodity price mover is reigning in liquidity with banks to bring down inflation expectations, which is trending at multiyear highs. India has been running an ultra tight monetary policy for the last eight months in an effort to bring down inflation expectations. Demand in these economies is showing signs of moderation with manufacturing index down to 29-month lows. Brazil, which till recently was raising policy rates to bring down inflation expectations, cut rates last month on the back of growth worries. The benchmark equity index in Brazil, the Bovespa is down by over 15% year on year. The index is weighted towards commodities with 50% commodity stock weight.
The market will not worry about RBI actions in taking down bond yields. A rate hike by the RBI in its September policy review will convince the market that growth will come off sharply leading to inflation expectations coming off. If RBI holds on to policy rates, the market will take it as a sign that the central bank is done with its policy tightening. Bond yields will trend down hike or no hike.
The RBI will look at domestic industrial production data for the month of July 2011 and the inflation data for the month of August 2011 while reviewing policy in mid September. The RBI has enough evidence of a potential slowing down in global growth with the weakness in equity market globally. Equity indices across the globe have lost between 6% and 18% in August on fears of economic slowdown. If industrial production and inflation data does not surprise on the upside, RBI will maintain rates status quo in September.
The ten year benchmark US treasury yield fell below 2% on Friday the 2nd of September 2011 after the poor non farm payrolls report. The yield on the benchmark ten year bond fell 14bps on Friday to close the week at 1.99%, which is close to record lows of 1.97% seen last month. The US employment data disappointed with no jobs added in August 2011 as against market expectations of job addition of 68,000. Unemployment rate stayed flat month on month at 9.1%. The weak job numbers added to concerns on US economic growth, leading to the sharp fall in ten year treasury yields.
The bond market is worried about another round of rate hikes by the RBI and is unwilling to take down bond yields in the face of weak growth issues in India and across economies globally. Ten year benchmark government bonds are trading at 8.35%, which is close to year highs of 8.48% seen in July 2011. The 7.80% 2021 bond, which is the benchmark ten year bond touched lows of 8.15% in August before climbing back to 8.35% levels. Weekly primary article inflation is trending at over 12.9% levels with food inflation at double digit levels. Primary article inflation has climbed from levels of 10.5% seen in July 2011 to 12.93% as of week ended 20th August 2011. Food inflation has climbed from levels of 7.5% to 10.05% in the same period.
Liquidity tightened last week by Rs 10,000 on the back of fresh product covering by banks in the first week of the reporting fortnight. Bids for repo at 8% averaged Rs 48,000 crores last week. Overnight rates traded at around 8% levels. Liquidity is expected to further tighten towards mid September due to second quarter advance tax outflows.
Government bond auction
The government auctioned Rs 11,000 crores of bonds last week. The bonds auctioned were the 7.99% 2017 bond for Rs 3000 crores, the 8.13% 2022 bond for Rs 6000 crores and the 8.30% 2040 bond for Rs 3000 crores. The cut offs came in at 8.39%, 8.46%, and 8.67% respectively. The government is scheduled to auction Rs 11,000 crores of bonds this week, which will be the last auction for the first half of this fiscal.