Bond Market Update July 2019

Benchmark 10 Year G-sec bond Yield closed at 6.41% yesterday, falling by 100 bps from the high of 7.4% just two months back. It touched low of 6.25% last week. The yields had scaled a peak of 8.18% on 11 Sept’18. Thereafter, there has been a sustained decline in yields till present with yields falling to an almost 30 months low on 16 July’19. Yields are just 23 bps away from breaching the decadal post demonetization low of 6.18%. On a 15-year period, yields touched 5.24% post the Great Financial Crisis.

What is driving yields lower?

The fall in yields in the recent 2-3 months can be mainly attributed to the following reasons:

  • 3 repo rate cuts undertaken by the RBI and expectations of a further rate cut in August’19.
  • Benign retail inflation and economic growth concerns which supports further rate cuts by RBI.
  • Easing banking system liquidity – The banking system liquidity has significantly eased during June-July’19. In the month of June and July’19, the banking system liquidity has witnessed liquidity surplus for a sustained period.
    • When the banking system liquidity was pressured during FY19, the RBI constantly infused liquidity almost aggregating Rs 3 lakh Crs. into the banking system via OMO purchases.
    • In the first quarter of FY20, Rs. 52,535 Crs. have been infused into the banking system by OMO purchase.
    • Also, RBI infused liquidity aggregating Rs 69,435 Crs. during March-April’19 by undertaking 2 long term rupee dollar swap
  • Announcements in the Union Budget on gross market borrowings and fiscal deficit –
    • Government has lowered the fiscal deficit to GDP ratio to 3.3% of GDP for FY20, 0.1% lower than the ratio budgeted in the Interim Budget.
    • In addition, the gross market borrowings programme of the central government was kept unchanged at Rs. 7.1 lakh Crs. However, the important point to note is 10% of the gross market borrowing i.e almost Rs 70,000 Crs will be by issuance of sovereign bonds by tapping overseas markets which will further reduce domestic supply.
  • Indirect impact of accommodative monetary policy stance by global central banks –
    • On account of concerns surrounding global growth, major central bank across the globe have shifted their stance to a relatively accommodative monetary policy and also plans to cut policy rates to reinvigorate domestic growth.
    • With central banks of advanced economies namely US Fed, ECB, BoE planning to lower interest rates or provide liquidity stimulus have driven treasury yields across countries lower and have indirectly made Indian government securities (G-Sec) an attractive investment alternative.

Conclusion,

  • G-sec Yields have cooled off owing to multiple favourable factors at play.
  • However, the corresponding decrease in Corporate Bonds spreads has not played out yet. This is likely to get better with Corporate spreads cooling off in the near-term.
  • The reduction in Corporate spreads will reduce the borrowing cost of corporates and aid in reviving corporate profitability. This could be the next trigger for the bull equity markets.

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