Going forward, we believe that the bond yields trajectory may remain in the narrow range. However, only the demand-supply dynamics will give further clarity on the trajectory.
The year started with bearish sentiments as the Reserve Bank of India, at its February 2017 policy meet, expressed concerns about stickiness of inflation, an uncertainty of the outcome of GST rollout, monsoon and US interest rates. This had set the bearish tone for the year.
At the beginning of 2017, investors expected a rate cut of 25 bps due to a prolonged pause in key rates as RBI changed stance from accommodative to neutral.
In H1FY18, we saw relief in the yields but traded in a range as RBI tone turned less hawkish along with moderating path of inflation and stable international commodity prices. It was further supported by a reduction in key repo rate by 25 bps to 6% in August 2017.
However, the second half of FY18 saw a reversal in yields and surged significantly by nearly 130 bps. The yields started rising from October 2017 on account of rising crude oil prices, tracking US counterparts, OMO sales by RBI, and concerns of fiscal slippage as the government announced Rs 2.11 lakh crore for the recapitalization of PSU banks.
In addition to this, the government announced additional borrowing of approx. Rs 70,000 crore in the last quarter of FY18 through dated securities and T-Bills. This further surged the yields as fears of assured fiscal slippage, firming up of inflation, and less clarity on GST collections built negative sentiments among market participants. The bond market saw selloff from major participants such as PSU banks on fear on rising yields impacting their P&L.
This further saw more negativity post the Union Budget 2018, where the fiscal deficit was revised to 3.5% (against estimated 3.2%) and a rise in MSPs (which could impact inflation). Along with this, the rise in yields of US bonds and US Fed rate hikes led to an additional bearishness in the market.
However, last week, we saw some relief in the bond yields after the government announced lower borrowing in H1FY19. It also added that in order to reduce pressure on the longer-dated securities, it will issue shorter maturity bonds along with inflation-indexed bonds. Going forward, we believe that the bond yields trajectory may remain in the narrow range. However, only the demand-supply dynamics will give further clarity on the trajectory.
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