Fixed Income
Market Update
and Outlook
Market Update
and Outlook
Market Update
Rising US Treasury, Strong US$, Elevated Crude and Bond
Inclusion
The main highlights of the September 2023 were the sharp rise in US treasury yield,
strong dollar and sharp jump in crude oil prices. Hawkish US Federal Reserve kept the
rate hike option open for future. Another significant event this month was India’s
inclusion in global bond indices.
India
Bond Inclusion:
After a long wait for years, India has been finally included in JP Morgan Global Bond
EM Index with a cumulative weight of 10% starting from June 2024. The estimated
inflows on account of this index inclusion alone are USD 21-22bn in FY25. In addition, if
India is included in other indices such as Bloomberg and FTSE, then additional USD
30bn of inflows are possible.
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
generalisation and persistence to headline inflation.”. With policy rate already
peaked, liquidity management continues to remain active tool. In October 2023
policy, RBI intends to use OMO (Open Market Operation) sales to keep liquidity tight
(to suck out durable liquidity).
Inflation:
After spiking to 7.44%y/y in July 2023, August 2023 CPI (Consumer Price Index) inflation
eased to 6.83% y/y (August 2022: 7%y/y). Headline print was better than consensus
expectations of 7%y/y. Decline in Inflation was driven primarily by favourable base
effect, sequential contraction in vegetables and benign momentum in fuel and core
prices. Core inflation continued to ease to 4.79%y/y (Jul 2023: 4.9%y/y; August 2022:
5.84%y/y).
Fiscal:
Apr-August 2023 gross & net tax collections grew robustly by 16.5%y/y and 14.8%y/y
respectively - driven by buoyant direct tax collections. Expenditure growth was
robust at ~20.3%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 ~36% of budget estimates (Apr-Aug FY23: 32.6%). September 2023
advance tax and GST data continued to indicate robust tax collections.
External Sector:
1Q FY24 (Apr-Jun) current account deficit (CAD) rose to 1.1% of GDP (4Q FY23: 0.2%; 1Q
FY23: 2.1%) aided by subdued crude prices, robust services trade and resilient NRI
flows. Foreign flows were buoyant driven primarily by robust foreign portfolio flows,
banking capital and external commercial borrowings (ECBs). 1Q Balance of Payment
(BoP) came in strong at US$24.5 bn (4Q FY23: US$5.6 bn).
August 2023 Trade deficit rose to US$24 bn (highest since Oct 22) driven mainly by
broad-base sharp rise in imports (oil, gold and core) indicating robust domestic
demand. Both exports and imports continued to contract (on adverse base effect) in
August 2023 and Apr-Aug 2023. Net Services exports continued to grow robustly at
16% y/y during the first five months of the financial year, thereby helping to improve
current account balances.
September 2023 saw negative FPI (Foreign Portfolio Investors) inflows (mainly in
equity) to US$ 1.6 bn (first negative flows since Jan-Feb 2023). Yet 1H FY24 (Apr-Sept
2023) saw overall strong inflows of US$21 bn – in sharp contrast to contraction of FPI
flows of ~US$5.5 bn in FY23.
Average Rupee continue to depreciate in Sept by ~0.3% m/m and stood at 83.05
during the month of September 2023(Aug: 82.78; Jul: 82.15, Jun: 82.23; May: 82.34; Apr:
82.02). Rupee has depreciated marginally by ~0.33% against dollar in CY23 till date.
Liquidity:
RBI discontinued with ICRR (Incremental Cash Reserve Ratio) of 10% in phased
manner with immediate implementation from Sept 8. The underlying idea was to
infuse the much- needed liquidity during the festive time. With this, the system
liquidity is expected to get boost of ~1.1 trn over the timeframe of month. As a result,
core liquidity (system liquidity+ government balances) improved to 3 trn by Sep’23
end from 2.5 trn at Aug’23 end.
Yield Levels & Spreads:
The month saw fixed income yields staying elevated – tracking rising US treasury
yields and elevated and volatile crude price. India’s inclusion in bond index and better
than expected monthly CPI print supported the market.
G-sec yields remained elevated - tracking UST (US Treasury) yields and crude oil
prices. Intra-month, CPI number and announcement of inclusion in JP Morgan bond
index provided much needed relief. Post calendar announcement, the yield curve
saw a steepening bias given the higher share of longer-end G-secs in the H2
borrowing calendar. 10-year G-sec moved in range of 7.14-7.24% during the month
and close the month at 7.21% (Aug’23 end: 7.17%; July’23 end; 7.17%, June’23 end :7.11%).
Money market rates remained elevated during the month on account of tight system
liquidity (advance tax and GST outflows). Lower net issuances of T-bills in 3Q FY24
(Oct-Dec 2023) was a positive for T-bill yields towards end of month.
10-year Term premia (10 yr over 365 days) eased to average 15 bps (Aug’23: 22 bps,
July’23: 26 bps, June’23:17 bps).
Like G-sec, SDL yields were elevated and moved in the range of 7.39-7.47% to close the
month higher at 7.46% (July-Aug 2023: 7.43%-7.44%, May-June 2023: 7.38%, Apr 2023:
7.46%). September 2023 SDL primary supply was robust at ~Rs.70,512 cr (Apr 2023: Rs.
22,300 cr, May 2023: Rs. 77,500 cr, June 2023: 67,900 cr, July 2023: 58,030 cr, Aug 2023:
Rs. 62,280 cr). The average spread between 10 yr SDL over G-sec stood at 25 bps
during the month (Apr 2023: 38 bps, May 2023: 32 bps, Jun-July 2023: 29-30 bps, Aug
2023: 25 bps).
Like G-sec & SDLs, AAA bonds yields were elevated during the month, with 10 yr AAA
PSU moving in the range of 7.58-7.69%. It closed the month higher at 7.68% (Apr 2023:
7.50%, May 2023: 7.41%, Jun 2023: 7.44%, Jul 2023: 7.53%, Aug 2023: 7.61%).
Global
Monetary Policy:
As expected, US Federal Reserve maintained policy rate unchanged and revised up
growth estimates. While keeping option for further rate hikes open, Fed revised down
interest rate cuts for next year. Resilient growth in form of hi-frequency indicators
globally is aiding higher for longer policy rate with upward bias.
Inflation:
US inflation rose further to 3.7% in Aug’23 from 3.2% level in July’23, on higher crude
prices. While global food prices have been in disinflation for ten consecutive months,
(with IMF’s FAO food index down by 7.5%y/y vis-à-vis 13%y/y one year prior), there is
currently uncertainty about food price outlook on El Nino concerns.
Financial Markets:
Month saw sharp increase in US treasury yields on huge treasury supply, strong
growth data, higher crude prices and rising concern of further rate hike. After starting
the month at 4.18%, the US 10 Yr Treasury bond yield moved rose to 4.61 levels by last
week of the month, only to close the month at 4.59% (Apr’23: 3.44%, May’23: 3.64%,
June’23: 3.81%, Jul’23: 3.97%, Aug’23: 4.09%). Dollar Index continued to appreciate by
2.2% in Sep’23 (1.7% in Aug). CY23 till date dollar index has appreciated 2.16%.
Market View
- August 2023 print came lower than market expectations pulled down mainly by food. Although seasonally prices of food are high (on account of lean period), the decline during the month was more of mean revert of veggies prices (on fading supply shock). Excluding veggies, headline CPI is lower at 5.46%y/y.
- With monsoon this year 6% below normal and diverge spatial spread, the cereal and pulses outlook will be closely monitored.
- With latest decline in monthly print and expectations of further decline in September headline inflation print, we believe that RBI may be in for long pause in FY24, with RBI probably monitoring evolving food price trajectory before acting.
- Till the time the inflation edges down to 5% level, we are of the view that RBI may actively manage liquidity ~1% of NDTL (Net Demand & Time Liabilities). With focus now on OMO sales in Oct’23 policy as active liquidity management tool, RBI 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 UST, Fed speak, crude oil etc along with evolving domestic inflation trajectory.
- India’s inclusion in global bond indices is relatively positive from a medium to long-term perspective, since this completely changes the context of Indian sovereign (Centre) bonds with FPI ownership of less than 2% of outstanding bonds.
Common Source:
RBI, CSO, FAO, CEIC, JP Morgan, US Federal Reserve, US Treasury department, Commerce Ministry of
India,
JP Morgan
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