Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Central Bankers: Stuck between rock (Inflation) and hard place
(Financial Contagion)
Year was marked by acceleration in inflation, followed by aggressive policy hikes to
record levels and tightening of financial conditions, resulting in concerns about
growth, currency and foreign flows. March 2023 marked the change in narrative from
inflation to financial stability. Central Bankers, who were ultra-hawkish at the start of
month, became attentive to financial contagion issue and even took synchronise
measures to address the issue (first such instance since Pandemic). That said, global
growth is still holding strong amid tight financial conditions and recession probability
is getting pushed forward to 2H CY2023.
Back home, March-23 saw gradual decline in inflation, robust fiscal print, lower
trade
deficit and better than expected 3Q CAD print.
Monetary Policy:
After aggressively front-loading in every single meeting of FY23 (total 250 bps in
current rate hike cycle), the RBI left the key policy rates unchanged in early April’s
meeting. This came as a surprise for markets since consensus expected 25 bps hike.
Rationale behind the pause was primarily: FY24 inflation to moderate to average
5.2%y/y (FY23 : ~6.7%) & to assess the cumulative impact of rate hikes in current cycle
on real economy. With current inflation above RBI’s upper bound, the RBI continues to
focus on ‘withdrawal of accommodative’ stance - to ensure that inflation
progressively aligns with the target.
Inflation:
After sharp jump in January inflation print, the inflation gradually moderated to
6.44%y/y in Feb 2023 (Jan 2023: 6.52%y/y). Although Feb print was in line with
consensus, the above 6% plus monthly print, despite favourable base effect, clearly
indicates the stubborn and elevated nature of inflation. The price inflation was driven
up primarily by housing, health, personal care, while the food, fuel and clothing &
footwear prices helped in bringing down the sequential momentum. Core inflation
remained sticky at 6.05% (Previous: 6.10%). Average YTD FY23 inflation print stood
elevated at 6.75%y/y (FY22: 5.51% y/y).
Fiscal:
Apr-Feb 2022-23 Tax collections continued to remain robust. While expenditure
growth accelerated since September (driven mainly by revenue expenditure),
February expenditure growth showed moderation driven down by muted capital
expenditure. Fiscal deficit remained at ~83% of RE (Similar to last yr’s, but lower than
pre-pandemic trend: 93%). Robust March GST data indicates that overall tax
collections till date continues to remain robust. Trends in current fiscal year indicates
that although the government has revised upward tax and expenditure targets for
FY23, the govt is likely to adhere to its FY fiscal target.
External Sector:
Trade deficit continued to surprise on downside for second month in row and stood
at US$17.4 bn (~Jan 23 lvl; lowest since Jan 2022; and lower than first three quarter
average for FY23 of US$23 bn). Improvement was primarily driven by broad based
decline in imports (core imports) & improvement in gold exports. That said, Apr-Feb
FY23 exports grew at 7% (driven by oil exports), while imports grew at 19% driven
primarily by high double digit oil imports (price +value effect) and resilient nature of
core imports.
3Q FY23 (Oct-Dec) current account deficit (CAD) eased to 2.2% of GDP, after jumping
sharply to 3.7% in 2Q. Latest print was lower than similar period last yr (2.7%). While high
CAD has been matter of concern since start of year, robust services and NRI flows
have helped in bringing down the quarterly CAD print within RBI’s comfort zone (~2%
of GDP). Further, after going into deficit in 2Q FY23 (~US$30 bn), balance of payment
(BoP) become positive in 3Q at US$11 bn, supported by banking capital & other capital
inflows & lower CAD.
After witnessing net outflow since start of CY2023, there was net FPI inflows in the
month (~US$700 mn). After depreciating in Feb 2023, Rupee appreciated marginally
in March. Average Rupee was ~82.3 during the month (Feb: 82.6; Jan 2023: 81.90,
Oct-Dec 2022:82). With this, rupee depreciated by 8.5% against dollar in FY23.
Currency movement during the year were primarily driven by volatility in UST yield &
dollar movement as well as RBI forex intervention.
Yield Levels & Spreads:
G-sec yields were range-bound during the month, with 10 year G-sec moving in the
range of 7.30-7.44 lvls. That said, first 10 days of the month saw 10 yr G-sec yields move
in range of 7.40-7.44 and easing down to 7.30-7.35 lvls for rest of the month on global
cues (Read: financial stability concerns). It closed the month at 7.31 levels (Feb: 7.43,
Jan: 7.36%, Dec: 7.33%, Nov end: 7.28%, Oct: 7.45%). Starting year at 6.9 lvl, 10 yr G-sec
closed the year at 7.31 - driven by front-loading of RBI policy hikes, sharp rise in UST &
strong dollar index.
10-year Term premia (10 yr over 365 days) continued to decline to average ~10 bps
during the month, on sharp rise in 1 year T-bill cut-offs & easing of 10year G-sec yield.
(Feb: 25 bps, Jan: 44 bps, Dec: 42bps, Nov: 46 bps, Oct: 58 bps, Sep: 77 bps).
Unlike G-sec, SDL yields moved up on higher SDL supply during the month. 10 yr SDL
traded in range of 7.64-7.71% to close the month at 7.70% (Feb: 7.68%, Jan: 7.63%, Dec:
7.55%, Nov: 7.58%, Oct: 7.76%). Mar SDL primary supply stood at ~Rs.1,39,000 cr (Feb: ~Rs.
84,000 cr, Jan: ~Rs. 78,000 cr, Nov-Dec: ~55,000 cr, Oct 22: 70,000 cr, May-Sep 22
monthly average ~50,000 cr). The average spread between 10 yr SDL over G-sec
increased to 32 bps during the month (Feb: 25 bps, Jan: 23 bps, Dec: 26 bps, Nov: 33
bps, Oct: 29 bps, Sep: 28 bps) - on rise in SDL yields.
AAA bonds yields were range-bound during the month, with 10 yr AAA PSU moving in
the range of 7.69-7.78% to close the month at 7.69% (Feb : 7.77%, Jan: 7.64%, Dec: 7.65%,
Nov end: 7.58%, Oct end: 7.76%, Sep end: 7.76%).
Inflation:
After muted uptick in Nov-Dec, sequential momentum in global inflation picked up in
January-February - driven by strong China demand and resilient demand in both
advanced and emerging economies. On other hand, Global food prices were in
disinflation for fourth consecutive month, with IMF’s FAO food index down by 8%y/y
vis-à-vis record 34%y/y in March 2022. That said, Inflation trajectory is expected to
remain above global central bankers’ comfort level for most part of CY2023.
Policy rates:
March 2023 turned out to be extremely volatile month. Starting the month on hawkish
tone with growth holding strong and still elevated monthly inflation print, the sharp
rise in financial stability concerns raise the fear of another kind of shock in making.
Global central bankers were immediately attentive to financial contagion risks and
even tone down their hawkish statements. As against the expectations of 50 bps hike
at the start of month, US Fed hiked the rate by 25 bps and even maintained US Fed
rate March projections at their Dec DOT plot levels (although US Fed chair has
indicated otherwise).
Financial Markets:
After starting the month on negative note amid hawkish global central bankers, the
US treasury yields eased across the curve for most part of the month, after the bank
run episode raise concern about financial stability. After starting the month at 4%, the
US 10 Yr Treasury bond yield eased to 3.38 by mid mid-month and then rose a bit
thereafter on expectation that global CBs continued to remain focused on inflation.
10 yr UST closed the month at 3.48% (Feb: 3.92%, Jan: 3.52%, Dec: 3.83%, Nov end: 3.68%,
Oct end: 4.10%, Sep end: 3.83%). Dollar Index appreciated marginally in March.
Market View
- Amid the rising global uncertainty, domestic macros remained resilient. Directionally and qualitatively for external balances (current account deficit) and internal balances (fiscal consolidation and Capex focus). Even inflation trajectory of gradual decline in inflation is intact, although there is rising concerns of food inflation from heat wave and El-Nino related drought.
- While Global Central Bankers(CBs) have changed their narrative – from inflation to financial sector stability, focus still continues to remain inflation control and CBs are likely to maintain ‘Higher for longer’ stance during CY2023.
- In a surprise move, RBI left policy rates unchanged in April-23 policy. While it did highlight upside risk to inflation and indicated that it may be data-dependent, we believe that current policy rate is likely to be terminal rate, since RBI has revised down the FY24 inflation projections. Hence, unless macro-data (growth, inflation) surprise on upside, policy rate has probably peak out.
Common Source:
RBI, CEIC, Finance Ministry, US Federal Reserve, Bank of England, ECB, JP Morgan CSO, MOSPI, IMF,
CGA, CCIL,
Budget Documents, NIMF Internal Research
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