Bond market may face some temporary headwinds: Jajoo

Fixed income markets took a breather this week after three straight weeks of decline with bond yields inching marginally higher. The reversal in sentiment was guided mainly by a delayed monsoon and a spurt in oil prices in international markets due to a fresh round of instability in Iraq. A denial from the government on any immediate plans to hike FII limits for investment in debt markets also impacted sentiment as the FII flow in bonds has been very robust in the last few weeks and the existing limits have largely been utilised.

A higher than expected decline in both the headline and core consumer price inflation (CPI) also did not help much as the US 10 year treasury yields also unexpectedly surged by another 8 bps to 2.65%. India’s May CPI inflation eased to 8.28% vs the April reading of 8.59%. A drop in food inflation to 9.3% from 9.6% last month supported the drop in CPI. Core inflation also fell to 11-month low at 7.72% YoY. The continued growth slowdown also triggered a fall in housing component of CPI. However escalation of political unrest in Iraq led to a quick sell-off in bonds as international Brent crude prices rose sharply higher almost to their nine-month high at $114/bl.

 
Benchmark 10-year government bond yields finally ended 8 bps higher at 8.59% from 8.51% last week. Domestic equities as well as the rupee faced similar pressure. The rupee closed weaker at 59.77 from 59.18 last week. Corporate bond markets bucked the trend with five year AAA bonds easing 6 bps from 9.15% to 9.09% and 10 year AAA bonds declining 11 bps to 9.08% from 9.19% in the absence of fresh supplies. In terms of other macroeconomic data points, April IIP accelerated to 3.4% YoY vs  -0.5% in March. India’s May trade deficit widened to $11.2 bn from $10.1 bn in April. While exports recorded a growth of 12.4% YoY, imports contracted by 11.4%. In other global news while Reserve Bank Of New Zealand hiked key rate by 0.25%, Bank of England governor Carney hinted at an early rate hike.

 

The rush for product covering ahead of scheduled advance tax payments kept the Overnight collateralised borrowing and lending obligation rates in the range of 8.25% to 8.50% in the beginning of the week. The rates eased close to 8% after Rs 61,000 crore was infused through regular 14 day term repo window at a weighted average rate of 8.26%. Although the borrowings from liquidity adjustment facility window rose to Rs 14,125 crore from Rs 2,845 crore, the window was still partially utilised. The marginal standing facility borrowings were negligible. As a result the shorter end of the curve remained well anchored. The three month PSU bank certificate of deposit rates ended marginally higher at 8.55% from 8.53%, while one year bank certificate of deposit rates closed flattish at 8.88%.

 
The bond market may face some temporary headwinds if global oil prices flare up further due to the ongoing geopolitical crisis in Iraq. Since the macro themes of easing trends in inflation trajectory and the hope of credible fiscal consolidation stays intact on domestic front the phases of corrections are likely to be short lived. Such opportunities should be used to add duration to the portfolio. As the overnight rates have stabilised ahead of advance tax outflows shorter end of a curve is expected to be stable.
 
Mahendra Jajoo is executive director & CIO-fixed income at Pramerica Asset Managers