Bond markets are usually a good lead indicator for both equities and currencies. Listening to the bond market can save or make a lot of money for investors. You should be cautious on equities and the Rupee now as bond markets are sill showing signs of nervousness.
The Sensex and Nifty are trading at close to record highs, while the Indian Rupee (INR) is trading at eight months highs. However government bond yields are trading at 130bps higher than levels seen eight months ago. The ten year benchmark bond is trading at yields of 8.80% and stubbornly refuses to acknowledge the rally in equities and INR.
FII’s have been net buyers of bonds for USD 5.9 billion in the first three months of calendar year 2014 while their equity purchases have been USD 2.6 billion. FII’s have bought more debt than equity but this has not helped bond yields come off.
Clearly the rally in Sensex, Nifty and INR has not rubbed off on the bond market. Why is this so? Bond market has been receiving largely positive data over the last three months. The government had cut its borrowing by Rs 150 billion for this fiscal and has shown a lower net borrowing for next fiscal as compared to this fiscal.
The government is running a large cash surplus with the RBI that provides a cushion for next year’s borrowing. The government has even bought back Rs 150 billion of bonds from the market to reduce cash surplus and increase liquidity in the system.
Inflation has come off sharply over the last four months with the CPI (Consumer Price Index) inflation coming off from 11.24% to 8.10% and WPI (Wholesale Price Index) inflation coming off from 7.52% to 4.68%.
Bank deposit growth at 15.5% year on year as of March 2014 is up from levels of 13% seen eight months back. The system has seen strong inflows from the FCNR B deposit swap window of the RBI with inflows of USD 34 billion in the September – November 2013 period.
The equity and currency markets are factoring in a Modi led NDA government at the center and are rallying on expectations of the new government pushing reforms and economic growth. Bond markets are yet to buy the story.
Is Dr. Raghuram Rajan the RBI Governor responsible for the bond market apathy towards the prospects of a better economy going forward? The Governor has raised the benchmark policy rate the Repo Rate by 75bps since the time he took over office last year. He has drawn attention to stubbornly high CPI inflation that has averaged over 9% over the last five years. He has adopted an inflation target of 6% and 5% for 2014 and 2015.
Liquidity is being made available to the market in the 8% to 9% band with 8% being the repo rate and 9% being the MSF (Marginal Standing Facility) rate. The sound bytes from Dr.Rajan suggests that he is not in a hurry to reverse policy decisions that were taken when the INR was trading at record lows against the USD in August 2013.
The INR is in a much more comfortable position now than it was last year with Current Account Deficit (CAD) expected to drop by over 45% this fiscal year as compared to last fiscal year. FIIs who sold INR debt of over USD 10 billion in the April-December 2013 period on account of worries of Fed withdrawal of stimulus have turned net buyers of bonds since January 2014. Markets have accepted the Fed asset purchase taper with purchases down by USD 30 billion since December 2013.
The bond market is not expecting any rate reversals next fiscal year given RBIs focus on inflation. The market is also worried on supply with the first half borrowing for fiscal 2014-15 commencing in April. Hence at this point of time, the bond market is not echoing the drums of the Sensex, Nifty and INR.
