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The yield of the Indian 10-year benchmark Government Security (G-Sec) could harden to about 7.50 per cent, tracking the rise in US Treasury yields, which are reacting to expectations of heavy bond supply due to a jump in the fiscal deficit, continuing price pressures, and the probability that the economy clocked strong growth in the third quarter.
The 10-year G-Sec (7.18 per cent GS2033) on Monday had closed at 7.3769 per cent yield, up about 16 basis points in the wake of the monetary policy committee keeping the policy repo rate unchanged at 6.50 per cent at its October 6th meeting.
‘Under pressure’
Market players expect Indian G-Secs to be under pressure due to the aforementioned developments in the US, the rise in crude oil prices, and the possibility of the RBI conducting open market operations (OMO) sales of G-Secs to suck out liquidity (about ₹42,000 crore) that has been released due to the expiry of a $5 billion USD/INR sell-buy swap on October 23.
They emphasised the need for the yield spread between the Indian 10-year G-Sec and US 10-year Treasury to widen to attract forex inflows.
“We expect the yield spread between India and US government bonds to normalise from current levels as India rates start to surge in the near term, given unfavourable dynamics (as crude oil prices to surge and the market awaits an OMO sale auction in the next few months),” said Nuvama Wealth Management’s Fixed Income market experts Aditya Gore, Ajay Marwaha,and Payal Shah.
They cautioned that participants in the India bond market seem to be undermining risks around a sharp surge in US Treasury yields, with a false sense of comfort likely to stay until the central bank announces the OMO sales auction.
Nuvama’s market experts observed that the spread between the 10-year US government bond and its Indian counterpart has been hovering around 400–500 bps historically. One basis point is equal to one hundredth of a percentage point.
However, since H2 (October–March) FY23, this spread has begun to narrow on account of a sharp jump in US Treasury yields. The yield spread between the two geographies narrowed to just 243 bps (on an unhedged basis) in early October as a significant rise in Treasury yields did not translate to a similar reaction in India.
The US 10-year Treasury yield had breached the 5 per cent mark on October 23rd before cooling off to 4.83 per cent. The yield spread between the 10-year benchmark papers of the two countries is now at around 252 bps.
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Gore, Marwaha, and Shah noted that India’s supply-demand dynamics are relatively more favourable than in the US, which is capping upside on rates. In addition, inflation readings have been coming in softer than expected, with trends in core CPI inflation also indicating disinflationary trends ahead.
However, this downside in Indian rates is unlikely to be sustained for long as US rates continue to inch higher. In addition, better-than-expected economic prints in the US have upped fears of the Fed hiking the rate once more this year.
“Importantly, in the long run, fundamentals drive yield movements, which are unfavourable as liquidity conditions are expected to remain tight for long (RBI has now resorted to active liquidity management as a tool for managing inflation and expressed readiness to conduct OMO sales for managing liquidity),” they said.
Kotak Mahindra Bank’s Economic Research team, comprising Upasna Bhardwaj, Suvodeep Rakshit, and Anurag Balajee, underscored that robust economic data, an upward surprise to the inflation readings, along with heavy bond supply in the US, continue to push US yields higher (particularly in the far end). Elevated crude oil prices further continue to keep markets jittery.
“Domestically, while bond supply remains comfortable, the fear of OMO sales continues to weigh on market sentiments.…We retain our expectation of a 10-year yield range of 7.25-7.50 per cent in the near term,” they said.
Venkatakrishnan Srinivasan, Founder & Managing Partner, Rockfort Fincap LLP, said even though the domestic bond market mainly reacts to domestic factors like OMO sales, inflation, deficit liquidity, etc., it does also react to external factors.
“The RBI may not be comfortable with our 10 year government bond spiking above its comfort zone. Hence, there could be buying interest from investors at 7.40 per cent and then at 7.45 per cent levels.
“...Considering the current market and geo-political situation, the bond market could be extremely volatile till March 2024…We expect the 10 year to trade in a wide range between 7.10 per cent to 7.50 per cent levels,” he said.
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