Positive catalysts to benefit rupee bonds, but sharp rally in 10-year bonds unlikely

Singapore: A mix of domestic and external positive catalysts are expected to benefit rupee bonds, but keeping down the long-end of the yield curve might prove a challenge, according to a report by Singapore bank, DBS Group, on Wednesday.

Global yields have declined in recent weeks, dragged down by the US Federal Reserve's recent dovish pivot.

This fall in yields reflect moderating growth expectations in the developed markets, and likely dovish-for-longer central bank policies, the report said.

Portfolio investors have returned to the regional high-yielding debt markets, including rupee bonds; after a two-month hiatus, FPIs bought a net debt of USD 1.6 billion this month, in addition to USD 4 billion into equities, wrote DBS Group Research Economist Radhika Rao and FX Strategist Philip Wee in the report.

Concurrently, a domestic swap measure has helped to reduce foreign exchange implied rates, making it cheaper for companies to raise funding in dollars and attract inflows.

The swap auction held on Tuesday saw banks offer cumulative USD 16.3 billion against a planned size of USD 5 billion; the Reserve Bank of India (RBI) accepted USD 5.02 billion worth offers.

The cut-off premium was set at Rs 0.776, not far from prevailing levels, capping forward premiums. The tool, released earlier in the month, will boost liquidity in the system in the midst of a quarter-end and financial year-end squeeze, according to the report.

"Add to this, rupee has also staged a relief rally benefiting from easing politics-led uncertainty, though we are less confident that this will sustain," said Rao and Wee.

Set against these developments, yields of the most traded 2028 rupee sovereign bond eased back below 7.5 per cent and (generic) two-year yields stayed at sub-6.6 per cent levels. The (generic/new) 10-year yield is back in the 7.30-7.35 per cent range.

The RBI's Monetary Policy Committee is expected to lower benchmark rates by 25 basis points at the next week's rate review, according to the duo.

Beyond the near term, longer-tenor yields are likely to find a floor as markets seek clarity on the frequency of similar swap auctions, likelihood of bond buybacks in 2019-20, and duration of the rate-cutting cycle.

Eyes are also on the borrowing schedule for first half of 2019-20, after the interim budget announced a record quantum of borrowings and bond issuances, according to Rao and Wee.