RBI gave a very soft view on inflation while lowering the repo rate and changing the policy stance. Bond markets will expect the RBI to keep rates down and liquidity easy in the system and this will drive down yields at the short end of the yield curve. Government bond supply expected to hit markets starting April 2019 will pressure the yields at the long end of the curve and this will lead to yield curve steepening.
The spread between the 5 and 10 year benchmark government bonds widened by 16bps post policy from almost zero levels. The 5 year bond yield fell while the 10 year bond yield rose leading to widening of the spreads.
The OIS curve too fell with both one and five year OIS yields falling on expectations of low repo rates and easy liquidity.
The short end of the credit curve looks most ttractive as one year CP spreads were at over 225bps over the repo rate and 3 year and 5 year AAA corporate bonds were at 149bps and 138bps over government bond yields respectively. RBI has made risk weights for banks lending to NBF’s rating specific from a 100% standard risk weight. The single issuer limit for FIIs at 20% was also withdrawan. Highly rated NBFCs and Corporates should see more demand for their bonds going forward given both spreads and regulatory changes.
RBI has spelt out its outlook on different factors affecting inflation and believes that oil and commodity prices can stay at lower levels on global growth concerns, food prices to stay down on supply overhang and consumer prices to stay down given a widening output gap due to slwodown in demand. Hence the market will play for rates staying down and liquidity being maintained at higher levels. which is positive for bonds at the short end of the yield curve.
The Fed is expected to refrain from rate hikes this year given soft global economic data and this will also keep risk aversion low in markets, which is positive for the INR and capital flows.
The interim budget for 2019-20 unveiled higher spending by the government on farmers and unorganized workers and tax sops for the middle class, which have led to fiscal deficit being set at 3.4% of GDP, higher than target of 3% of GDP. Read our Budget note for details. The result of higher fiscal deficit is higher borrowing by the government and this is leading to supply concerns for the bond market and this will pressure bonds at the longer end of the yield curve.