The Incremental CRR announcement will add volatility to bond yields. However, yields will fall after rising initially as CRR is a temporary move. Read our note on Incremental CRR.
Government bond yields swung violently on Friday with the ten year benchmark bond, the 6.97% 2026 bond, seeing yields rise by 10bps from lows seen during the day to close at levels of 6.23%. The bond yield closed 20bps down week on week as the market factored in a 50bps rate cut by the RBI.
Demonetisation and the ensuing liquidity have completely distorted money markets. On the liquidity front, banks parked just over Rs 5 trillion with the RBI as deposits surged. The fact that demonetization has prompted the market to lower GDP forecasts, increased bets on a sharp rate cut by the RBI. One and five year OIS yields closed at 5.96% and 6.07% respectively, down by 15bps and 16bps week on week. OIS markets are expecting the repo rate to drop to 5.75%, a 50bps cut from current levels of 6.25%.
Treasury bill rates are down below 6% even as the RBI is sucking out money through term reverse repos at 6.24%. Markets are worried that if RBI runs out of gsecs to use for reverse repos, it may limit the amount to be bid for reverse repos, and this would flood the market with liquidity and crash money market yields. However, this may not happen, as RBI understands the distortion it can cause.
In this event driven and liquidity driven market, bond yields will react sharply to any positive or negative news or rumors. There will be more such Fridays where bond yields move up or down sharply intraday. Volatility will be high and may unnerve many market participants.
The ten year benchmark bond, the 6.97% 2026 bond saw yields fall by 20bps week on week to close at levels of 6.23%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields fall by 23bps to close at 6.32% levels while the On the Run bonds, the 7.88% 2030 bond and the 8.13% 2045 bond saw yields fall by 30bps and 29bps respectively to close at levels of 6.46% and 6.64%. Gsec yields will see violent swings on the back of demonetization and liquidity.
OIS market saw one year OIS yields close down by 15bps and five year OIS yields close down by 16bps week on week. One year OIS yield closed at 5.96% while five year OIS yield closed at 6.07%. OIS yield curve will steepen in the coming weeks as markets factor in easy liquidity and rate cuts.
Credit spreads closed mixed last week. Three-year benchmark AAA corporate bond yields fell by 23bps week on week to close at 6.63% levels. Credit spreads rose by 2 bps to close at 55bps levels. Five-year benchmark AAA bond yields fell by 20bps to close at 6.76% with spreads rising by 1bps at 52bps levels. Ten-year benchmark AAA bond yields fell by 26bps to close at 6.96% levels with spreads down by 6bps at 63bps. Credit spreads are likely to go down on expectations of rate cut and surge in system liquidity,
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in surplus of Rs 5153 billion as of 25th November. The surplus was Rs 3899 billion in the week previous to last. Government surplus was Rs 117 billion last week, down by 250 billion week on week. Liquidity will continue to surge as banks deposits increase on demonetization.
