Bullish govt bonds reflect slowdown in global and domestic economies

While government bonds have rallied in the recent past on domestic rate cut expectations and comfortable liquidity, the rupee has remained relatively choppy. The currency is mirroring the equity market, reflecting a slowdown in the global and domestic economies.
 
Indeed, global bond yields have fallen quite substantially, with some in Europe hitting sub-zero levels, an early sign of a global slowdown. Investors rush to buy fixed income investment during uncertain times. As yields fall, prices of bonds rise.
 
The yields on the 10-year bond fell to a 31-month low on Tuesday, and closed at almost same level at 6.34 per cent. However, rupee fell to 68.83 a dollar, from its previous close of 68.72 a dollar, following its Asian peers. So far this year, the rupee has gained 1.38 per cent.
 
“Global dollar strength and weak risk sentiment amid escalation of trade tensions weighed on the domestic currency,” said currency consultant IFA Global in a market wrap. Most of the other Asian currencies also weakened against the dollar, while the benchmark Sensex rose 0.22 per cent, or 84.6 points, to close at 39,215.64 points.
 

The bond market, meanwhile, has fully factored in a rate cut in the August policy, say bond dealers. While the difference between the repo rate and bond yields has remained around 100 basis points, the difference is about 58 basis points.
 
Many are attributing the drop in bond yields to risk aversion among investors, while others said say this is akin to what has been playing out in the equities market since last year.
 
“Equity markets have been huge polarisation with large-caps performing well but mid- and small-caps correcting. This is nothing but flight to safety. Investors are seeking refuge in companies perceived to be relatively safe, having low debt and strong corporate governance practices. Similarly, in the bond market investors are buying sovereign paper amid rising defaults,” said an analyst with a foreign brokerage.
 
So far this year, Nifty has gained 7.6 per cent, while the Nifty Midcap 100 and Nifty Smallcap 100 have declined 5 per cent and 7 per cent, respectively.
 
But the rally in government bonds has surprised many.
 
Since the Budget announcement on July 5, the GSec yields have declined by 36 basis points, and the decline in yields was 60 basis points in the previous one month (from 6.93 per cent on 17 June to 6.33 per cent on July 16), noted CARE Ratings in a report.
 
“The recent rally has been quite fast and dramatic,” said Suyash Choudhary, head, Fixed Income, IDFC AMC.
 
“The recent three rate cuts undertaken by the RBI and the expectations of a further rate cut in the forthcoming MPC meeting has been key factors which have pulled 10-year GSec yields…,” said CARE Ratings.
 
According to Choudhary, comparing the recent fall with demonetisation level may not be the right comparison.
 
“…the current phase is that of a synchronised global slowdown, where local fiscal policy so far has been relatively disciplined,” Choudhary said.
 
The bond market has been aided by massive liquidity support by the secondary market bond purchases by the RBI. In the last fiscal, the government purchased a record ~3 trillion of bonds from the secondary market.