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What does the Fed rate cut mean for Indian bond yields?

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The sharp fall in G-Sec yields in the past month have already priced in Fed’s action; a steep 50 bps cut by the RBI next week can trigger a further rally
BL Research Bureau

The Fed delivered on expected lines and cut rate by 25 basis points. Slowing global growth has nudged central banks across the globe to tilt towards monetary policy easing. While the Fed action has opened up the possibility of more rate cuts by the RBI, Fed Chairman Jerome Powell's remarks that the central bank is not intending to embark on long cycle of rate easing has dampened broad hopes of four cuts in the coming year.

Hence for now yield on 10-year Indian government bonds should remain in the 6.3-6.4 per cent mark, having already factored in Fed's Wednesday rate action.

Read also: Fed cuts interest rates, signals it may not need to do more

However growth concerns on the domestic front, have raised expectations of a sharp 50 basis point cut by the RBI in the upcoming policy.

After the sharp fall of 60 bps in the 10-year Indian government bond yields over the past month, can yields fall further?
Uncertainty over foreign sovereign bonds

G-Sec yields over the past month have been volatile, owing to uncertainty over foreign sovereign bond issuance. While bond yields moved down after the Finance Minister, Nirmala Sitharaman proposed the move in the Budget, they intermittently went up on news reports of the plan being put off. With subsequent assurances coming in from the finance minister that the issuance plan is on track, bond yields fell again below the 6.4 per cent mark.

So what’s the big deal over such issuances?
For the current fiscal, the Centre’s gross market borrowings are at a high ₹7.1 lakh crore (from Rs 5.71 lakh crore last year). The move to raise part of this overseas can ease oversupply of government bonds in the domestic market, in turn lead to lower yields.

Given that the Centre’s borrowing programme is front-loaded (62 per cent in the first half of the current fiscal) supply conditions are also expected to ease in the second half. For the April-September 2019, issuance of government securities amounts to Rs 4.42 lakh crore; the balance Rs 2.68 lakh crore of gross borrowings will come in the second half. If the foreign sovereign bond issuance does happen (most reports indicate about Rs 70,000 crore), then the supply in the domestic market will be even lower at Rs 1.98 lakh crore.

“Assuming the talked about $ 10 billion sovereign issue goes through during October-March period, net supply of government bonds drops to just about 22% of the first half net supply”, says Suyash Choudhary, Head – Fixed Income at IDFC AMC.

Expectations of far lower supply of government bonds in the second half of the current fiscal has led to fall in yields.

Demand dynamics
Domestically, PSU Banks sitting on large investments in government bonds were huge net sellers in government bonds in 2018-19-- net selling ₹37,670 crore. In the current fiscal so far (upto July) they continue to be net sellers to the tune of Rs 64,629 crore. While credit growth remains weak, modest deposit growth has impacted liquidity. It needs to be seen if demand from PSU Banks pick up substantially in the coming months.

Interestingly mutual funds were net sellers in the beginning of 2019, but have turned net buyers in the past four months.

Foreign investors pulled out about Rs 42,000 crore in 2018-19. In the current fiscal so far, they have gradually been evincing interest---net buyers to the tune of Rs 13,900 crore. Currently they are using 74 per cent of their in government bonds (all categories).

High interest rates have always attracted foreign investors to Indian bonds. Currently the nominal returns on Indian bonds even after the sharp fall over the past month remains attractive at 6.3 per cent. US 10-year bond yields are at about 2 per cent. In Many other economies yields are in the negative territory.

On a nominal basis, Indonesia offers high rates on its 10-year bonds, at 7.3 per cent; the real returns after taking into inflation work out to about 4 per cent. In India real returns work out to about 3 per cent.

Even if the RBI cuts repo rate sharply, Indian bond yields will remain attractive, keeping foreign investor interest intact. A strong rupee will aid further.

On balance, yield on 10-year G Sec may remain range bound in the 6.3-6.4 per cent range. A sharp rate cut by the RBI however may see yields move lower, given the not so unfavourable demand supply dynamics........................................BL