The 10 year benchmark G Sec yield declined by 6bps to end the month at 7.34% in anticipation of a dovish RBI policy on concerns of global growth slowdown. The US yield curve (10 year – 3 month T Bill) inverted for the first time since the 2008-09 global financial crisis, prompting markets to shift into risk-aversion mode. The FOMC was unexpectedly dovish in its March meeting as median “dots” signaled no rate hikes in 2019, and one in 2020 (down from a median three hikes through 2020 at the December meeting). Fed officials also announced the end of balance sheet reduction. German bond yields fell significantly and turned negative for the 1st time since 2016 on erosion of inflation and growth expectations.
The Consumer Price Index (CPI) inflation for the month of January’19 stood at 2.57%, higher than previous month’s 1.97% owing to fall in prices of fruits and vegetables primarily. The Consumer Food Price Index (CFPI) inflation rate continued in negative territory at -0.66% in February’19. Wholesale Price index (WPI) inflation stood at 2.93% for February’19 compared to 2.76% in January’19.
The Government has frontloaded its borrowing plans, with the H1 FY20 gross borrowing of the Government at INR 4.42trn, amounting to 62.3% of the total gross borrowings for FY20. Along with this government has also announced the T-bill calendar, where INR 200bn of T-Bills supply will hit the markets every week. In order to infuse durable liquidity in the system, RBI has decided to inject Rupee liquidity for longer duration through long-term foreign exchange Buy/Sell swap. In March RBI successfully conducted a USD 5bn swap for a tenor of three years. The US Dollar amount mobilized through this auction would also reflect in RBI’s foreign exchange reserves for the tenor of the swap while also reflecting in RBI’s forward liabilities.
The 10-year benchmark G-Sec yield declined by 6bps to end the month at 7.34%, largely tracking the decline in global bond yields and risk-off sentiments globally. Globally the theme of slowdown continues to dominate the markets. In its Federal Open Market Committee (FOMC) meeting the Fed kept its policy rate steady and turned even more dovish on the back of worries over US economy. Further it intends to start slowing the pace of its balance sheet normalization process in May and end it in September.
Outlook:
In the first monetary policy review of the FY20, the Monetary Policy Committee (MPC) decided to cut repo rate by 25 bps (4:2 majority) while keeping stance neutral (5:1 majority). The Reserve Bank of India (RBI) has cut both its growth and inflation forecast as well. GDP growth forecast for FY 20 has been cut to 7.2% with risks evenly balanced. CPI projections have been revised further lower, to 2.4% in Q4 FY19, 2.9 – 3% in H1 FY 20 and 3.5 – 3.8% in H2 FY 20, with risks broadly balanced. Importantly, forecast for Q4 FY 20 at 3.8% is still below the mid-point of RBI’s target range. The accompanying monetary policy report (MPR) pegs Q4 FY 21 estimate at 4.1%. For FY 21 structural models indicate inflation will move in a range of 3.8 – 4.1%, assuming a normal monsoon and no major exogenous or policy shocks.
Given the global and local backdrop we expect there is more easing in the pipeline. The introduction of the forex swap tool for liquidity has had a very benign effect on short end rates, given that it has caused hedge costs to fall by around 100 bps. The spread between 4 - 5 year corporate bonds to 10 year has now risen to almost 70 bps. This may be a large reason why the 10 year may also tend to find anchor. Our preference remains for spread assets like SDL and AAA corporate at the 10 year point. Spreads versus underlying government bonds have shrunk versus what they were in early March and we believe there may be more room to go given the underlying environment and policy thrust on transmission.