Pro-growth RBI minutes; Caution in US Treasuries

INR yields capped by pro-growth RBI. Still neutral on US Treasuries.
Radhika Rao, Eugene Leow22 Aug 2019
    Photo credit: AFP Photo

    India rates: Pro-growth RBI minutes to cap yields

    INR 10Y (generic) government bond yields are likely to stay below 6.7% after yesterday’s RBI minutes revived expectations for further policy easing. Minutes from the August policy meeting saw the committee members highlight weakening growth as a dominant worry. Consensus was that the domestic slowdown had been accompanied by spillover impact from weaker global activity, pushing the output gap to negative. The decision to lower the repo rate by 35bp was backed by 4-2 vote, with the dissent votes for a smaller 25bp cut.

    With RBI projecting inflation at below target over the next four quarters, the door for cuts remains open. We suspect further downward growth revisions might trigger further rate response (DBSf – cut in 4Q19). Admittedly, markets will be split on the scale of cuts that could be forthcoming, after the unconventional move in August. With 110bps cuts already undertaken and another likely in 4Q, the debate over remaining policy space is beginning to surface.

    Transmission will be accorded the highest priority, as the RBI’s moral suasion attempts, surplus liquidity and consideration of an external benchmarks nudged banks to act. Handful of banks trimmed their lending rates after the August cut, whilst few others moved to link lending rates to the repo rate. It is a matter of time before banks also tie the liabilities-side (i.e. deposit rates) to external benchmarks as well.

    While supportive RBI minutes cap yields, 10Y yields have risen by over 20bps in the past fortnight on worries over a pending stimulus package, for sector-specific support. While awaiting details on the stimulus measures, 10Y yields are likely to hover in the 6.5-6.6% range. 2Y yields are still below 6% and likely to remain so as rate cuts return to the horizon.

    Rates: Caution in the US Treasuries space           

    The US Treasuries market has become more cautious in recent days as the drumbeat of fiscal stimulus got a tad louder in the Eurozone. Coupled with speculation of ultra-long tenor (50Y, 100Y) issuances from the US Treasury and Fed minutes indicating that this is just a mid-cycle adjustment (not the start of a major Fed easing cycle), some uncertainty premium has worked its way into the curve. We maintain our neutral view, noting that the market has already priced in 4 more rate cuts over the coming year. Insurance cuts should not amount to more than 2-3 and we suspect that the bond market may be overly pessimistic on the economy. However, until there is greater clarity on Brexit and the ongoing China-US trade war, investors will probably continue to seek safety in G3 govvies, keeping yields somewhat depressed. 
    Aggressive fiscal stimulus (either from Germany or the US) would probably be needed to change the supply-demand mismatch in govvies. While a possible EUR 50bn (0.4% of Eurozone GDP) German stimulus will be welcomed, this amount is probably too small trigger a round of tantrums. In any case, Germany would need to endure another quarter of negative growth before purse strings get loosened. Meanwhile, watch for further policy cues at the upcoming Jackson Hole symposium.

    Radhika Rao

    Economist – India, Thailand & Eurozone

    Eugene Leow

    Rates Strategist - G3 & Asia

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