SGSs still look compelling; INR yields news-driven with a downside bias

We expect India and Singapore govvies to rally further.
Radhika Rao, Eugene Leow25 Jun 2019
    Photo credit: AFP Photo

    Rates: SGSs still look compelling      

    By many measures, SGD rates (especially govvies) still look very cheap. Since we flagged up in early June (see PDFHTML), the SGS curve has bull steepened with 2Y yields down by 20bps. The market has been more reticent in bringing down longer term rates on account of the 20Y auction with the 15Y tenor unchanged over the same period. Meanwhile, without a direct headwind from the auction, the interest rate swaps have outperformed govvies in the longer tenors. The SGS-swap spread is firmly inverted (yields higher than rates) across the longer tenors (>5Y). We think the spread looks stretched and should normalize back towards zero. Some of this can be attributed to still tight SGD liquidity which could dissipate in the coming months. 

    10Y SGSs offer the highest absolute yield within the AAA-rated (by the three major rating agencies) space. Even when we include US Treasuries, SGSs are a close second. With the amount of negative yielding debt approaching USD 13tn, yield is scarce. We think it would only be a matter of time before foreign investors start to notice. Moreover, USD/SGD cross currency basis swaps are also favorable for USD-based investors looking to hedge off currency risks while earning a pickup. Inverted bond-swap spreads, a relatively steep curve and high absolute yields mean that SGSs look like a compelling long compared to peers.

    India rates: Yields are news-driven with a downside bias into the Budget

    Ahead of next week’s Budget presentation, INR government bond yields remain news driven. 10Y yields (generic) have been choppy within a wide trading range of 6.76-6.95% since last week, closing at 6.85% yesterday. 

    Speculation that the FY20 fiscal deficit target might be raised by 20bp to -3.6% of GDP unsettled markets, preventing a sharper pullback in the yields (DBSf -3.4% of GDP target). On the revenues end, a decision on the transfer of surplus funds from the Reserve Bank of India (RBI), which would have helped the exchequer, has been deferred again to July. Higher spending and slower revenue generation have raised concerns over the fiscal stance in next week’s Budget and underpinned longer-tenor yields. 

    Despite the news-driven volatility, we continue to expect 10Y yields to be biased for further downside. Soft global yields on weak growth prospects and likelihood of ‘insurance’ cuts by the US Fed, along with a cautious European Central Bank, have weighed on Indian rates. 

    The undertones from the recent Minutes from the RBI’s June meeting, when rates were lowered 25bp and the policy stance changed from neutral to accommodative, remained dovish. In a surprising turn of events yesterday, RBI Deputy Governor Viral Acharya resigned, citing personal reasons, around six months before his term ends. With a relative hawk stepping down, the monetary policy panel’s policy leaning is likely to turn more dovish at the margin. This reinforces our call for another 50bp cut in the rest of FY20 (see here). On the fiscal end, despite the wariness, we don’t expect a sizeable miss in the targets, even as the underlying math assumes optimistic tax and non-tax projections. 

    In the meantime, domestic liquidity conditions are supportive with two tranches of OMOs this month, which effectively nets off a good part of the planned weekly bond issuance.  While we hold out for further correction in the 10Y yields, slippage in the rate-sensitive shorter tenors have been sharper. From an elevated 6.8% in late-April, 2Y yields have tumbled to 6.2%, heading towards our quarter-end target, as below-target inflation spur expectations for further cuts. 6% beckons next for the short-tenor as local and global conditions remain favourable.

    Eugene Leow

    Rates Strategist - G3 & Asia

    Radhika Rao

    Economist – India, Thailand & Eurozone


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