Domestic 10-Year Yield Declines In February & Continues Downward Trend
In February 2024, the domestic 10-year yield experienced a notable decrease of 7 basis points (bps), followed by an additional 2 bps decline in yesterday's trading session. This downward movement was bolstered by sustained buying support from Foreign Portfolio Investors (FPIs), driven by resilient macroeconomic indicators and increasing confidence in fiscal prudence. Notably, the longer end of the yield curve shifted downward entirely, with even the 3-month paper showing a significant moderation in yield. As of 29 February 2024, the gap between the 3-month and 30-year paper widened to 30 bps from 23 bps at the end of January 2024.
Insights from Domestic Market Auctions
Auctions in the domestic market during February 2024 reflected a general downward trend in cut-off yields, with State Development Loans (SDL) witnessing a sharp drop. Despite this, pressure on liquidity persisted:
The average system liquidity deficit moderated to Rs 1.9 lakh crore in February 2024 from Rs 2.1 lakh crore in January 2024. The Reserve Bank of India (RBI) conducted fine-tuning operations, with the frequency of Variable Rate Repo (VRR) auctions being higher than Variable Rate Reverse Repo Rate (VRRR) auctions, keeping liquidity range-bound.
Liquidity conditions remained tight, as evidenced by VRRR auction results showing offers received lower than the notified amount. The call money rate remained above the repo rate, hovering at 6.67 per cent.
System liquidity is expected to be in the range of 1.0 to 1.2 per cent of Net Demand and Time Liabilities (NDTL). The gap between incremental credit and deposits in FYTD24 stood at Rs 3.2 lakh crore, indicating medium-term pressure on liquidity.
Durable liquidity also faced pressure, decreasing to Rs 1.7 lakh crore as of 29 February, 2024, from Rs 1.8 lakh crore on 31 January 2024. This was attributed to the increase in currency in circulation, which has been rising since January 2024 and is expected to continue increasing in the coming months.
The second leg settlement date of the Rs swap is scheduled for 11 March 2024, which is anticipated to inject around Rs 40,000 crore of liquidity into the system, with its impact closely monitored.
Outlook on 10-Year Yield for the Next 30 Days
The outlook for India's 10-year yield over the next 30 days suggests it will likely remain in the range of 7.00 to 7.10 per cent. Domestically, the yield narrative differs from global trends, with the delayed rate-cut response of major central banks being a dominant factor. However, downward pressure on domestic yields is expected due to comforting inflation figures and robust demand from FPIs in the debt asset class. A sub-7 per cent yield cannot be ruled out.
US 10-Year Yield Trends Upward
In contrast, the US 10-year yield continued its upward trajectory. Despite indications from major Federal Reserve officials that the policy rate has peaked, they emphasise the need for a balanced macroeconomic approach to easing. Firm core Personal Consumption Expenditures (PCE) data and sticky inflation expectations, as indicated by the University of Michigan, suggest a cautious approach to monetary policy. While some macroeconomic indicators softened, such as the ISM manufacturing print and consumer confidence index, the possibility of a rate cut is only visible from the second quarter of CY24 onwards, according to the CME Fed watch tool. The upcoming testimony of the Fed Chair before Congress and payroll data will provide further insights into future monetary policy decisions.
"India’s 10Y yield got support from buoyant demand from FPIs. In Feb’24, there were inflows of US$ 2.7bn in the debt segment. Going forward, resilient domestic macros, fiscal discipline and easing price pressure would put further downward bias on yields.
We expect 10Y yield to remain in the range of 7-7.10% in the current month. Liquidity deficit is likely to persist and remain in the range of 1.0-1.2% of NDTL. Durable liquidity would come under further pressure due to expected increase in currency in circulation in the coming months," said Dipanwita Mazumdar, Economist, Bank of Baroda.
