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Bond Markets Reprice Higher Rate Expectations

Our View:

We continue to expect rate hikes by the MPC beginning October with 50-75 bps rate hike by the end of FY2027, in order to keep real rates positive. In the near term, we expect the 10yr bond yield to trade in a range of 6.95% -7.25%.  

The short end of the yield curve will continue to be supported by surplus banking liquidity and less supply of CDs from banks due to FCNR inflows going ahead. Investors with short term investment horizon can look to allocate in 3-6 months maturity segment.

 

Indian Markets:

Bond yields rose across the curve in the first fortnight of September as crude oil surged amidst heightened geopolitical risks and global bond yields surged in response to higher inflation and expectations of rate hikes by the US Fed. This is after the FCNR (B) flows surprised massively on the upside with USD 127 bn coming in and flooding the banking sector with liquidity, which rose above INR 8trn. The surprise came not only from the final inflows under FCNR scheme but also from the pace as the flows almost doubled from Aug 21, when RBI announced an early closure to the scheme.

The durable liquidity is estimated to be around INR 14 lac cr and to drain out the excess liquidity, RBI announced an OMO sale of INR 1 lac cr which further pressurised the upward pressure on yields. The liquidity surplus is at its highest since COVID and we expect more measures from RBI to drain the surplus liquidity. The short term money market yields, which had fallen sharply due to the massive FCNR inflows have also risen with the 3 month maturity Bank CD yields rising by  20-30 bps from its lows. The deluge of liquidity had made the yield curve steepen as short term yields were supported by the surplus liquidity while the longer end of the yield curve was weighed down due to higher global bond yields and higher crude but as the RBI announced the OMO sale, concentrated predominantly in short term securities maturing up to 5yrs, the curve flattened a bit.

The benchmark 10yr Bond yield has risen 15bps so far this month while the 5yr bond yield is up 19bps. The longer end bond yields (30yr & 40yr) were also higher by 10-11 bps. INR depreciated by 0.70% with RBI continuing to intervene in the spot market as well as conducting sell/buy swaps to drain liquidity. Brent Crude spiked to USD 107/bbl, up almost 18% so far in the month.

CPI inflation came in line with expectations at 4.82% though both food and core inflation registered an uptick. “Core” inflation came in at 4.20%, which suggests some passthrough of higher input costs. WPI inflation stayed elevated at 9.92% with “core” WPI at 8.10%. The last 3 months average WPI is at 9.90% with monthly momentum remaining firm in August. As crude prices cross USD100/bbl amidst firm food prices, both WPI and CPI will maintain the uptrend, with CPI expected to rise sharply next month towards 5.50% or higher.

Banking sector deposits grew at a faster clip with a 17.80%  YoY growth, reducing the gap with credit growth, which recorded a growth of 19.10%. The deposit/credit growth wedge which had risen to over 5% has now come down to 1.50% as a result of the FCNR deposit flows. As a result of these bumper FX inflows, the Balance of Payment (BOP) is now expected to end the year at a strong surplus of close to USD 50-60bn. The OIS curve yields also rose with the 1yr OIS yield moving up by 10bps and the 5yr OIS yield moved up by 20bps.

FPI flows turned negative for both debt and equity as higher crude, elevated global bond yields and geopolitics issues dampened sentiments.

 

International  Markets

Global bond yields continued to rise with higher US inflation leading the markets to expect a September rate hike from the US Fed. The US 10yr benchmark bond yield went above the psychological level of 5%, up 27 bps so far in the month. Japanese and European bond yields also rose  with markets pricing in a US Fed and BOJ rate hike later this week.

 

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