Bond markets had a bad week with RBI and the government delivering bad news. Bond yields rose 14bps last week with the ten year benchmark bond the 8.79% 2021 bond yield closing at calendar year highs of 8.42%. The outlook for bond yields is negative in the near term as markets digest the bad news but going into April, bond yields will trend down on easing liquidity conditions and on hopes of repo rate cuts by the RBI in its April 2012 annual policy meet.
RBI refrained from reducing the repo rate in its policy review on the 15th of March, citing latent inflationary pressures due to administered prices and due to the government’s inability to contain its fiscal deficit. Markets worried on whether RBI will delay reducing repo rates in fiscal 2012-13 and started factoring in lower than expected quantum of rate cuts. Bond yields gave up ground on the back of markets worries on RBI policy easing in the next fiscal.
The government too delivered a blow to the bond markets by announcing a higher than expected borrowing for fiscal 2012-13. Government announced a gross borrowing of Rs 569,000 crores against market expectations of Rs 550,000 crores. Ten year bond yields reacted negatively to the higher borrowing with yields rising by 8bps post the budget announcement. Bond markets were not too enthused by the lower fiscal deficit projections of the budget at 5.1% of GDP against a revised fiscal 2011-12 estimates of 5.9% of GDP. The market is worried about the quantum of borrowing and it’s demand-supply equations rather than relative fiscal deficit ratios.
IIP (Index of Industrial Production) growth for January 2012 printed higher than market expectations of 2% at 6.8% while inflation for February 2012 came in at 6.95%, which was higher than market expectations of 6.75%. Economic data did not favor bond markets last week adding to the poor sentiments in the market.
Liquidity tightened last week with liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) tightening by Rs 24,000 crores week on week. Advance tax outflows negated the release of Rs 48,000 crores of liquidity through a 75bps CRR (Cash Reserve Ratio) cut that came into effect last week. Liquidity will continue to remain tight in the next fortnight due to fiscal year end demand for money by the system. Money market securities rates stayed at higher levels despite the CRR cut with three month CD (Certificate of Deposit) rates at 11.5% levels and one year CD rates at 10.95% levels. CD yields will look to trend down in the last week of March as outlook for April liquidity spurs buying at higher levels of yields.
Interest rate swaps saw the curve trending higher on the back of rising government bond yields and on the back of disappointment over policy rates staying status quo. One year OIS yields moved higher by 5bps and five year OIS yields moved up by 15bps week on week. The five over one segment of the OIS yield curve gave up some of its inversion with the spread coming off by 10bps to close at a negative 59bps levels. The OIS yield curve will give up more of its inversion in the coming weeks on the back of expectations of liquidity easing in April.