Worst is not over for bond market

Another volatile week passes by with the US Treasury moving past the 3% mark mid-week before fresh buying of the US notes pushes the benchmark yield lower. The Indian bond yields its US counterpart in terms of direction, albeit for different reasons. The benchmark 10-year bond yield remained above 7.70% for a large part of the week. Equities are flat across markets while emerging market currencies somewhat weaker.

The key focus at the start of the week for the rates market was the outcome of the policy review by the European Central Bank (ECB). The ECB in its monetary policy review kept interest rates unchanged and from the policy statements and press conference, it looks fairly certain that it is expected to remain same for an extended period. The bank further stated that the net asset purchases will remain at the existing rate of EUR30 billion until the end of September 2018, or beyond, if necessary.

The crude oil prices settled slightly higher as the likelihood of the US pulling out of an Iranian nuclear deal that may eventually cripple global supplies, kept trader sentiments weak. Weekly auctions of the US Treasury notes suggested robust demand alongside decent bid-to-cover as US unemployment claims dropped to its lowest in nearly half a century.

The Indian bond traders and investors continue to fight agony as sentiment remains woefully weak as yields have almost entirely reversed the gains one witnessed in the last week of March and early April. That, all three successive auctions saw devolvement, even at the shorter end, is a commentary on how brittle confidence is. While one can attribute the recent spike in crude prices and the surge in the US yields as possible reasons for the firming up domestic yields, these were not unknown factors.

One of the possible reasons for recent bearishness is that the minutes of the April policy threw a hawkish shock as opposed to seemingly dovish take on the policy day. Dissipating concerns on growth, extra watchfulness on inflation (even though FY19 CPI forecast was lowered in the policy) and additional emphasis on second-round effects of HRA implementation and Minimum Support Prices appear to have dominated MPC’s discussions.

Bond traders generally look out for signals and they appear to be perceiving an apparent disconnect between the hawkish minutes against a somewhat dovish policy statement. With the spread between overnight and five years at 180 basis and further up, the curve nearly flat beyond five years, a front-loaded rate hike appears to be the logical thinking. Even assuming a few hikes over the next 18 months, the belly looks rich with fewer supplies.

The continuous devolvement of three successive auctions (two government securities and one state loans), market is sending a signal that the worst is not over yet. Unless there are structural changes in both liquidity and inflation expectations, caution is advised. The risk to reward favours investment over trading and the three-five year tenors are extremely attractive for carry trades.

NO RESPITE YET

• Indian bond traders and investors continue to fight agony as sentiment remains woefully weak
   
• One of the possible reasons for recent bearishness is that the minutes of the April policy threw a hawkish shock

The writer is a market expert