During the last one week, the 10-year bond yields decisively settled above the 8% mark. After touching a high of 8.06%, the bond yields settled around the 8.03% mark. What is material is that 8% is not the psychological barrier anymore and now appears to be the new normal. Why was the level of 8% breached so suddenly during the week? There are 3 things to understand here.
Rate hike soon enough…
Like it or not, but another rate hike may be inevitable in the next few weeks. The INR has already touched the 72/$ mark and despite some support at 72, it looks unlikely to sustain for too long. The CAD at 2.4% may be a temporary respite but the pressure of CAD touching 2.8% by the end of the year still remains. If the trade deficit figure stays around the $18 billion mark in the next few months then 2.8% CAD may not be too far off. That is already putting pressure on the INR. Additionally, with oil hovering around the $80/bbl mark in the Brent market, inflation in India will remain under pressure. An inflation level of around 5% appears to be the norm going ahead. The impact of higher MSP on Kharif crops could only put further pressure on the inflation front. Above all, the government may be keen to keep the yield gap high enough to sustain flows into India. All these factors clearly hint at a rate hike, which is reflected in the bond yields. For now, 8% yields may be the new normal.
Banks need better yields
The last few years have seen banks writing off bad loans in an aggressive manner. But there are still pain points like the power sector, which could add to the pressure on banks. They have another challenge. They need to quickly get back to profitability and that has to coincide with better yields. At the current yields, the banks are realizing that they may not be left with too much leeway to operate, especially considering the losses that they are taking on the NPA front. We have already seen the largest bank, SBI, hiking its rates by 20 bps and that only hints at higher yields.
Largely about capital flows
But the markets are expecting that the government may falter on its fiscal deficit targets by a big margin. That would put pressure on the government to sustain its capital flows through the FDI and the FPI source. The FDI growth has already saturated and is unlikely to grow sharply till the new government is in place by middle of next year. FPIs have withdrawn nearly $10 billion in the previous four months and that is the money that the government will be targeting to bring back. That is only possible with higher bond yields and a strengthening rupee. A couple of rate hikes could create that salivating combination. That is exactly what the yields are indicating!