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As anticipated bond markets witnessed huge volatility during the week. The 10 year benchmark fell below 8.70% twice in alternate bouts. The first downward move came after exit polls which indicated a possibility of stable government. The next round of rally began as soon as trends indicated on May 16 that BJP led NDA was on verge of land slide victory. Both these rallies were short-lived though. The bond markets which had begun on a firmer note tracking exit poll projections saw an initial sell-off with 10-year yield nudging higher to 8.80% following a disappointment on CPI (consumer price inflation) front. The April print stood higher at 8.59% versus 8.31%. Food inflation which had eased for four consecutive months reversed the trend to firm up on account of unseasonal rains and hailstorms. The core CPI remaining broadly unchanged at 7.80% limited the downfall in bond prices.
Thereafter the 10-year bond recovered and consolidated in the band of 8.74%-8.78%. However the market which was pricing in NDA victory erased all its gains following election results as worries about new fiscal roadmap and rising retail inflation resulted in a correction. The 10-year bond finally ended 8bps higher at 8.83% from 8.75%. In terms of other economic data, the April WPI stood lower at 5.20% against the consensus expectations of 5.70%. The index of industrial production (IIP) reading for the month of March fared mildly better at -0.5% YoY, but continued to contract for the fifth straight month. The movement in corporate bonds was non-linear towards closing hours due to lack of volumes in closing hours. As a result the five year AAA bonds ended the week 5bps lower from 9.42% to 9.37%, while 10-year AAA fell 7bps from 9.42% to 9.35%.The rupee displayed its best six month performance against its Asian peers ending at 58.78 from 60.03 as election results reignited the hopes of rating upgrades from various international agencies.
In global markets the dollar gained further strength against the euro as one of the ECB board member hinted that in order to spur lending, ECB may offer long term loans to banks and reiterated the possibility of reduction in interest rates. The hope of additional stimulus from ECB, persistent unrest in Ukraine and weak housing index data in the US triggered fresh round of bidding in US 10-year treasury which made a new three month low of 2.49% ending at 2.52%, easing 10bps from levels of 2.62% last week.
The overnight rates stayed higher in the range of 8.50 to 9.00%.The huge government bond redemption of Rs 28,000 crore helped ease pressure on overnight rates by weekend with overnight rate drifting below 8%. The liquidity adjustment facility borrowings stood lower at Rs 8,914 crore from Rs 20,923 crore. The marginal standing facility borrowings were negligible. The 14 day term repo weighted average cut-off stood at 8.23%.The easing forex premiums on rupee-dollar pair and lower cut off on 14D term repo resulted in a renewed demand at short end of a curve. The three month PSU bank certificate of deposit rates fell 2bps from 9.03% to 9.01%, while one year CD rates fell 9bps to 9.13% from 9.22%.
Going forward the market is likely to closely watch new government’s action plan on fiscal road map and inflation. Since the NDA with its clear majority is in position to form the next government without support of any other political parties, it will have more flexibility to follow the path of structural economic reforms and fiscal consolidation. Such situation augurs well for domestic currency as well as the overall macro picture of an economy. Till the announcement of the Union Budget for FY2014-15 and revised borrowing programme, government bonds may not gain significantly but the buoyant rupee, expectations of further rise in FII flows into domestic markets shall keep rate markets well supported on upsides. Thus, the recent correction in bonds provides a fresh opportunity to accumulate government bonds.
Mahendra Jajoo is Executive Director & CIO - Fixed Income at Pramerica Asset Managers
