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Fixed income markets had another rollercoaster ride last week. While bond yields rallied massively till Thursday to 8.15% registering a new recent low since July 15, most of these gains evaporated following the Reserve Bank of India’s monetary policy on Friday which was unexpectedly more hawkish than market consensus. In the early part of the week the rupee appreciated further to 61.77 from a close of 63.50 in the previous week, an appreciation of close to 3% on the back of improved dollar flow, a dovish Fed and renewed FII buying.
In anticipation of a start in the reversal of recent tightening measures on improved sentiment in the rupee, money and bond markets also rallied. Three-month bank certificates of deposit (CD) rates collapsed almost 100bps to touch 9.65% while benchmark 10Y government bond yield eased 34 bps to 8.15%. What further added to the positive sentiment was the fact that much against broader markets consensus of a commencement of tapering and against its own earlier guidance, the Fed decided to defer the tapering until it got more confidence in incoming data. However, RBI's monetary policy review on Friday put the focus back on elevated inflationary expectation. While RBI did reduce the marginal standing facility (MSF) rate by 75 bps from 10.25% to 9.50%, it also increased the repo rate by 25 bps from 7.25% to 7.50%. RBI also brought focus back on consumer price inflation (CPI), which it suggested has remained very high for a number of years and has resulted in diversion of household savings from financial instruments. Reacting to the unexpected hike in the repo rate, bond markets gave up most of the gains of the week to close on a very weak note. As the MSF rate was reduced though, money markets were able to retain most of the gains for the week. In summary, benchmark 10-year yields closed 10 bps higher for the week at 8.58% after touching an intra-week low of 8.15%. Three-month bank CDs were lower by 85 bps at 9.80% and one-year bank CDs were lower by 65 bps at 9.60%.
A hike in repo rate has turned the market sentiment bearish again. While the Fed has delayed the tapering for the time being, markets will continue to face volatility on an ongoing basis as tapering expectations will now fluctuate with every data release. This week has large auctions aggregating Rs 50,000 crore, the deferred dated security auction of the previous week and for the current week at Rs 30,000 crore and the state loan auction of Rs 9,500 crore and regular T-bills auction of Rs 12,000 crore. With policy guidance for a possible further hike in repo rate, already bearish sentiment and large dose of supply, this week is expected to witness further spike in bond yields. Friday’s auction though may provide good value as by that time, most of the negatives may already be priced in by the traders.
