New Delhi [India], October 15 : Government bond yields may face further upward pressure as continued liquidity absorption by the Reserve Bank of India (RBI), expectations of additional rate increases and elevated global yields keep markets cautious, according to a report by Union Bank of India (UBI).
The report said the pace and composition of the RBI's liquidity absorption through open market operation (OMO) sales, further foreign exchange swaps and reserve accumulation under the Foreign Exchange Reserve Ratio (FERR) would shape domestic liquidity conditions and the outlook for government securities (G-secs).
“The pace and composition of RBI’s absorption through OMO sales, any further FX swaps and net reserve accumulation under FERR will shape liquidity conditions,” the report said.
It added that movements in the weighted average call rate (WACR) --the average overnight lending rate between banks-- relative to the repo rate, along with banks' participation in longer-tenor variable rate reverse repo (VRRR) auctions, would indicate how lenders are adjusting to a narrowing liquidity surplus.
Government bond yields have risen since the end of September. As of October 14, the 10-year G-sec yield stood at 7.40 per cent, up around 20 basis points from September-end, while the five-year yield rose around 22 basis points to 7.25 per cent. The 30-year yield also increased to 7.82 per cent from 7.67 per cent over the same period.
UBI said global developments would remain central to the outlook for the rupee and domestic bond yields, particularly crude oil prices, US Treasury yields and movements in the dollar.
Crude oil prices above USD 100 per barrel, elevated US Treasury yields and dollar strength have continued to add to inflation and external-sector pressures, the report noted.
The report also highlighted the impact of the RBI's recent foreign exchange measures, following which the rupee strengthened to around 95.04 against the US dollar. The currency appreciated around 1 per cent from September end and 1.8 per cent since October 9.
However, UBI cautioned that the recovery in the rupee had not removed concerns in the bond market, as liquidity withdrawal and expectations of further policy tightening continued to weigh on government securities.
The report further said the extent of further liquidity absorption and changes in money-market conditions would be important indicators for assessing the direction of bond yields. Global oil prices, US Treasury yields and dollar movements will also remain key factors shaping the domestic debt market outlook.