Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Geo-political conflict, Rise in US treasury yield, Strong Dollar
Index and Volatile Crude Oil
Globally, October 2023 saw rise of geo-political risk, strong US data (growth, non-farm
employment data), sharp rise in US treasury yields (on high supply), global Central
bankers (US federal reserve & European Central Bank [ECB]) on hold, acceleration of
crude prices, strong dollar and thereby pressure on emerging economies’ fixed
income market, currencies & flows (including India). Robust fiscal, better than
expected inflation print and neutral monetary policy provided respite to Indian fixed
income market.
India
Monetary Policy:
In October 2023 policy, the RBI maintained the status quo on policy rate and left
monetary stance unchanged - in line with consensus expectations. While retaining
FY24 inflation and growth outlook, RBI highlighted upside risk to inflation in form of
“the recurring incidence of large and overlapping food price shocks can impart
generalization and persistence to headline inflation.”. With policy rate already
peaked, liquidity management continues to remain an active tool. In October’23
policy, RBI announced it can use Open Market Operation (OMO) sales to keep liquidity
tight (to suck out durable liquidity).
Inflation:
After spiking to 7% range in July-Aug 2023, September 2023 CPI inflation eased to
5.02% y/y (September 2022: 7.41%y/y). Headline print was much better than
consensus expectations of 5.5%y/y. Decline in Inflation was driven primarily by sharp
sequential contraction in food inflation, decline in fuel and housing prices and benign
momentum in services prices. Excluding vegetables headline inflation remained
steady at 5.14%y/y (Previous month i.e.Aug-23: 5.46%y/y; Sep 2022: 6.76%y/y). Core
inflation continued to ease to 4.53%y/y (Aug 2023: 4.79%y/y; Last year same period:
6.07%y/y).
Fiscal:
1H FY2023-24 (Apr-Sep) gross & net tax collections grew robustly by 16.3%y/y and
14.7%y/y respectively - driven by buoyant direct tax collections. Expenditure growth
was robust at ~16.2%y/y driven primarily by emphasis on capital expenditure
(especially road, railways, transfer to States) & pick up in revenue expenditure. As a
result, Fiscal deficit stood at ~39% of budget estimates (Apr-Sep 2022: 37%). October
2023 GST data continued to indicate robust tax collections.
External Sector:
September 2023 Trade deficit eased to US$19 bn (Aug 2023: US$21.7 bn) driven down
mainly by decline in core imports. Both exports and imports continued to contract
(on adverse base effect) in Sep and Apr-Sep 2023. Net Services exports continued to
grow robustly at 15% y/y during first half of financial year, thereby helping to improve
current account balances.
October 2023 saw negative FPI inflows (mainly in equity) to US$ 2.1 bn (Second
consecutive month of negative flows). Yet Apr-Oct 2023 saw overall strong inflows of
~US$19 bn – in sharp contrast to contraction of FPI flows of ~US$6 bn in FY23.
Average Rupee continue to depreciate in Oct’23 by muted ~0.2% m/m and stood at
83.24 during the month
(Sep 2023 :83.05, Aug 2023: 82.78). Rupee has depreciated marginally by ~0.60%
against dollar in calendar year 2023 till date.
Liquidity:
October 2023 saw complete reversal of Incremental Cash Reserve Ratio (ICRR) hike
leading to increase in liquidity during the month. Core system liquidity (system
liquidity + Government balances) improved from 3 trillion in Sep 2023 to 3.3 trillion by
end of Oct-23, despite festive season demand.
Yield Levels & Spreads:
Oct’23 saw fixed income yields rising on backdrop of global cues (sharp rise in
geo-political risk, US treasury yields and crude price) & OMO concerns. 10-year G-sec
yield (which was moving in the range of 7.20-7.24 at the start of the month), rose
sharply, post Israel- Hamas conflict & OMO announcement in RBI Policy, to move in
range of 7.35-7.39% during the month. It did ease to 7.30-7.32 range mid-month
driven by better-than-expected monthly inflation print. 10 yr Gsec closed the month
at 7.35% (Sep 2023 end: 7.21%). Money market rates remained elevated during the
month on tight liquidity driven primarily by festive season and higher government
balances. 10-year Term premia (10 yr over 365 days) rose to 21 bps (Sep 2023: 15 bps).
Like G-sec, SDL yields harden post Israel conflict and were in the range of 7.50-7.67%
to close the month higher at 7.67% (Sep 2023: 7.46%). October SDL primary supply was
robust at ~Rs.92,639 cr (Sep 2023: Rs. 70.,512 cr). The average spread between 10 yr SDL
over G-sec stood at 27 bps during the month of Oct’23 (Sep 2023: 25 bps).
Like G-sec & SDLs, AAA bonds yields rose sharply during the month (Oct’23), with 10 yr
AAA PSU moving in the range of 7.7.61-7.72%. It closed the month higher at 7.70% (Sep
2023: 7.68%).
Global
Monetary Policy:
In early Nov 2023 policy, US Federal Reserve maintained policy rate unchanged, while
keeping option for further rate hikes open on robust growth and resilient labour
market. That said, the tight financial and credit conditions (reflected in sharp rise in
US treasury yields), pass-through of previous rate hikes and improving supply is likely
to keep US Federal Reserve on hold over next couple of months.
Inflation:
US inflation stayed elevated at 3.7% in September 2023 (after staying in range of 3%
in June-Jul 2023). While global food prices have been in disinflation for eleven
consecutive months, (with IMF’s FAO food index down to negative 10.7%y/y vis-à-vis
5.3%y/y one year prior), there is currently uncertainty about food price outlook (on El
Nino concerns). Similarly, there is uncertainty on near term inflation outlook on
elevated crude prices.
Financial Markets:
Oct’23 saw sharp increase in US treasury yields on rise in geo-political tension, huge
treasury supply, strong growth data and higher crude prices. After starting the month
at 4.81%, the U.S. 10yr Treasury bond (UST) yield rose to 4.98 levels by mid-month on
rising concern of Israel Hamas conflict, only to ease to close the month at 4.88% (Sep
2023: 4.59%). While the month saw 10 yr yield moving up 20 bps, yields have hardened
by 90 bps since July 2023 end.
Sharp rise in UST and risk off sentiment globally led to appreciation of Dollar Index by
1% in Oct 2023 (2.2% in Sep 2023). Calendar year (2023) till date dollar index has
appreciated 3%.
Market View
- September’23 print came lower than market expectations at 5% handle - pulled down mainly by food. Although, seasonally prices of food tend to be high (on account of lean period), the decline during the month was more of mean revert of veggies prices (on fading supply shock).
- Core inflation is now at 4.5% and expected to remain muted in 2H (Oct-March) FY24 helped by favourable base effect and muted sequential momentum.
- With 2H (Oct-March) FY24 average headline inflation expected to decline to 5.4% (Average July-Sep 2023: 6.4%), we believe that RBI may be in for long pause in FY24.
- That said, we expect RBI to actively manage liquidity as effective policy instrument. With focus now on OMO sales in Oct’23 policy as active liquidity management tool, RBI has clearly indicated that it has shifted from temporary removal of liquidity measures (like ICRR) to durable one (OMO sales).
- Going forward, Fixed income markets are likely to take global cues like geo-political risk, U.S.Treasury (UST), Fed speak, crude oil etc along with evolving domestic inflation trajectory.
Common Source:
RBI, Central Statistical Office (CSO), FAO, CEIC, JP Morgan, US Federal Reserve, US Treasury
department,
Commerce Ministry of India, NIMF Internal Research.
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