Macro Strategy

Positive catalysts for Indian bonds; EM FX outlook
Radhika Rao, Philip Wee27 Mar 2019
    Photo credit: AFP Photo

    India rates: Positive catalysts, but sharp rally in 10Y bonds unlikely
    A mix of domestic and external positive catalysts are expected to benefit INR bonds, but keeping down the long-end of the yield curve might prove a challenge.
    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. Portfolio investors have returned to the regional high-yielding debt markets, including INR bonds; after a two-month hiatus, FPIs bought net debt of USD1.6bn this month, in addition to USD4bn into equities.
    Concurrently, a domestic swap measure has helped to reduce FX implied rates, making it cheaper for corporates to raise USD funding and attract inflows. The swap auction held yesterday saw banks offer cumulative USD16.3bn vs a planned size of USD5bn; the RBI accepted USD5.02bn worth offers. The cut-off premium was set at INR0.776, not far from prevailing levels, capping forward premiums. The tool, released earlier in the month, will boost INR liquidity, in midst of an end-quarter, end-FY squeeze. 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.  
    Set against these developments, yields of the most traded 2028 INR sovereign bond eased back below 7.5% and (generic) 2Y yields stayed at sub-6.6% levels. The (generic/new) 10Y yield is back in the 7.30-7.35% range. The RBI-led policy committee is expected to lower benchmark rates by 25bps at next week's rate review.
    Beyond near-term catalysts, 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 FY20, and duration of the rate-cutting cycle. Eyes are also on the borrowing schedule for first half of FY20, after the interim budget announced a record quantum of borrowings/bond issuances.

    FX: Signs of renewed emerging market stress
    About a year ago emerging markets were stressed by a more hawkish Fed hike stance. While EM currencies have fared well from the Fed’s pause in recent months, they have not welcomed the Fed’s latest dovish tilt. In pushing the US 10Y bond yield below the Fed Funds Rate, this has given rise to fears of a synchronised global slowdown. It did not help that US consumer confidence in March came in at 124.1, well below the 131.4 consensus. Emerging Asian currencies should also pay attention to the weak Argentina peso for signs of renewed emerging market stress.
    The Argentine peso hit a new record low of 42.72 on Tuesday. According to a survey of economists by the central bank, the peso is expected to depreciate further to 48, the upper half of the central bank’s pre-determined band between 39.26 and 50.81. Argentina is struggling with a recession at a time when the central bank is hiking rates to contain high inflation and a government committed to a balanced budget under its IMF package. Investors are worried that this negative mix may hurt the re-election prospects of market-friendly President Mauricio Macri at the general elections in October.

    Radhika Rao

    Economist – India, Thailand & Eurozone

    Philip Wee

    FX Strategist - G3 & Asia

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