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Bond markets had little to celebrate in the post-Diwali week with yields rising sharply across the curve on renewed fears of further repo rate hikes due to higher inflation and accelerated tapering by the Fed on stronger economic data in the US. The initial trigger for the sharp spike in yields last week came for a fresh sell-off in rupee as in response to a sharp appreciation of the dollar in global markets and on news of a part of the dollar demand of oil marketing companies getting routed through the open market. Markets did not see any respite as the rupee continued to weaken and auction supplies begin to weigh in the absence of any indication of any imminent open market operations.
All key US economic data came in far stronger than consensus with Q3 GDP at 2.8% vs 2% consensus, jobless claims sustaining their lows at 335,000 and non-farm payrolls for October sharply higher at 204,000 against consensus of 120,000 further strengthening the dollar against major global currencies with the euro weakening to 1.3375, its weakest in a month. The US 10-year treasury rose sharply by 14 basis points (bps) to 2.74%. The ECB reduced its refinance rate by 25 bps to 0.25% from 0.50% to aid prolonged economic recovery. S&P maintained its negative outlook on India with a warning of downgrade post general elections if new government fails to implement structural reforms to revive the economy. The rupee hit a fresh two-month low of 62.75 during the week before it recovered to 62.47. Benchmark 10-year government securities yield shot up to 8.99% up by 31 bps. Ten-year AAA ended at 9.75% up 18 bps, while five-year AAA ticked 22 bps higher to 9.72%. Higher yields in corporate bonds saw some buying interest from nationalised banks and insurance companies.
Dependence on borrowings from the marginal standing facility window continued to be lower at Rs 7,130 crore. Liquidity conditions eased in the beginning of the week on higher government spending as three month certificate of deposit rates fell 15 bps to 8.74%. Gains did not sustain as three month CD rates ended the week 8 bps higher at 8.90%, while one-year CD rates ended 10 bps higher at 9.17%. The sell-off at the shorter end was also attributed to the fact that for some time the market has been building expectations of the operationalisation of a repo rate by RBI which is likely to get deferred in the events which coincide with pressure on the currency.
Key economic data points are scheduled this week. These include inflation (both WPI and CPI) and index of industrial production (IIP). The market consensus for WPI and CPI is placed on the higher side at 6.90% and 9.90% (Bloomberg Survey) respectively. Food inflation is unlikely to bring much respite on account of festive demand. Given the strong growth in core sector IIP at 8% there might be some improvement in the overall IIP data for the month of September. Higher inflation expectations coupled with weaker currency and re-emergence of Fed taper talks globally will all weigh on domestic bond markets this week. At these levels there is a case for open market operation support from RBI as such as significant upward shifts in long term yields if sustained can further amplify the inflationary expectations.
Mahendra Jajoo is executive director & CIO-fixed income at Pramerica Asset Managers
