Country Report | Finance & Economy

Debt Market Report – March 2023

Published: March 4, 2023

Global Overview 


  • The US financial market has been influenced by the release of positive macroeconomic data, leading to  expectations of higher interest rates for a longer period. Strong retail inflation, personal consumption  expenditure, purchasing managers index, and retail sales figures indicate the economy’s continued strength.  The housing market also showed signs of improvement. Additionally, a strong labour market contributed to  the possibility of rate hikes in March, May, and June. In fact, as per the CME’s FedWatch tool there is a 25%  probability of a 50bps hike at the March FOMC meeting. The Fed funds rate projection for the December  2023 meeting has been repriced to 5.25-5.50%. 
  • Minutes from the February meeting indicated that some participants favoured a 50bps rate hike and indicated  that the financial conditions have eased in recent months. The upcoming March 22 meeting will be influenced  by inflation and job reports, with consensus estimates for payrolls in February at 200,000 and a marginally  higher unemployment rate of 3.5%. However, high services inflation may keep headline inflation from  moderating significantly. Unless there is a significant deviation from these key indicators, US Treasuries may  remain under pressure, and the dollar is expected to rise as yields increase. 

Europe (ex-UK) 

  • In Europe, the market was affected by the ECB officials’ hawkish comments and mixed data releases, which  created uncertainty about the region’s outlook. Retail sales and industrial production figures were below  expectations, while composite PMI number albeit higher, failed to impress due to the stagnant manufacturing  sector. Both investor and consumer confidence remained low. Preliminary estimates of EU GDP showed a  slowdown in Q4 to 1.9% YoY from 2.3% in the previous quarter, with improving trade balance being the  only positive indicator benefiting from falling energy costs.  
  • However, major economies such as Germany, France, Spain, and Italy continued to report high headline and  core inflation levels, along with healthy consumer confidence and PMI indicators. The ECB policymakers are  determined to bring inflation back to the 2% target, leading to expectations of a 50bps rate hike in March  and a terminal rate of around 4% by year-end. This suggests that the ECB could continue raising rates  through 2023. As the US monetary policy expectations are being repriced, the EUR may experience some  downward pressure from current levels. 


  • In the UK, high-frequency indicators have provided a mixed picture, creating uncertainty about the Bank of  England’s policy decision at the next meeting. At the February monetary policy meeting, the Committee  voted for a second consecutive 50bps rate hike but hinted that smaller hike or even an end to the hiking  cycle may be possible in the next meeting. Despite the BOE’s signals, the market has been focused on  improvement in recent economic data releases such as PMI, consumer confidence, retail sales, and industrial  production. With improving economic data and only a slight moderation in inflation, markets are factoring in  a terminal rate of 4.5% in the next meeting. However, the tight labour market presents upside risks to  inflation, brushing aside the possibility of rate cuts this year. Going ahead, dollar strength and a  disadvantageous interest rate differential could continue to put pressure on GBP and UK gilts. Japan  
    • The nomination of Kazo Ueda as the incoming Bank of Japan governor was a significant event for Japan’s  financial markets. Contrary to expectations that Ueda would push for policy normalisation, he sees the current  loose monetary policy stance as appropriate. Ueda has stated that inflation would need to rise “significantly”  higher to justify an exit from the current policy, which is necessary to boost wages and growth. The increase  in inflation to over twice its 2% target in January has been supported by a weaker yen and rising input  prices. On the policy front, while there may not be an immediate change in policy when Ueda assumes his  position on April 8, there could be some revisions to the yield curve control framework and/or new exit  strategies discussed over the course of the year. 

    India Overview  

    • In February, the RBI MPC meeting voted 4-2 in favour of a 25bps rate hike, citing concerns over sticky  core inflation, leaving the door open for further rate hikes. Probability of future rate hikes further increased  after retail inflation numbers spiked to 6.5% in January. The headline number was elevated due to a higher than-expected surge in prices of cereals, pulses, and protein items, as well as stubbornly high core inflation  of 6.3% caused by elevated costs in segments such as housing, healthcare, and personal care. 
    • Looking ahead, there are some factors that could provide relief from inflationary pressures. A favourable  base, healthy wheat, and pulses production (as per the second advanced estimate for 2023), supportive  government measures to cool off prices, and the fizzling out of pent-up demand, especially in the service  sector, could all contribute to easing inflation. However, there are still some potential upside risks to food  inflation, particularly from adverse climate conditions. The IMD has warned of an enhanced probability of  heatwaves between March and May in central and north-west India, which are key wheat-producing  regions. Additionally, the emergence of El-Nino conditions also poses an upside risk to inflation. 
    • The Overnight Index Swap (OIS) market has already begun pricing in rate hikes following the last policy  meeting, with the 1-year OIS rate inching above 7%. While the 10-year benchmark bond yield rose 7bps  to 7.45% in the last one month, the spread between the 10-1-year yield narrowed sharply as liquidity  conditions and rate-hike bets pulled yields on the short-end sharply higher. The spread between the 10-1- year yield narrowed sharply, from 44bps at the start of February to 17bps by end February. 
    • The India-US interest rate differential has been a key factor weighing on the rupee, with the Fed expected  to continue hiking rates and the dollar strengthening. As a result, the rupee depreciated over 1% in  February, although RBI intervention helped limit the fall. 
    • From a policy perspective, we believe there is a possibility of another 25bps rate hike in April, given the  renewed upsurge in CPI inflation. As core inflation remains stubbornly high and the likelihood of a rate hike  increases, upward pressure on yields will continue. We see the 10-year bond yield trading within the 7.4- 7.5% range over the next couple of months before easing towards 7.3% in H1 FY24. Further easing of  bond yields to the 7-7.2% range could be expected in H2 FY24 as domestic inflation cools, and global  tightening of monetary policy comes to a halt. 
    • Meanwhile, the rupee may remain exposed to volatility in the near term, as we see a further narrowing of  the India-US interest rate differential. For H1 FY24, we expect the rupee to see a further downside of 85/$  before retreating towards 81/$ levels in H2 FY24. For the second half of FY24, we anticipate the rupee  appreciating on the waning dominance of the dollar and moderation in India’s current account deficit.
      The yield curve flattened further in February on account of a sharper rise in short-tenor bond yields. The rise  was driven by tightening of banking system liquidity. This saw the spread between the 10-1-yearyield narrow  as much as 17bps, its lowest since 2018. Repricing of rate hikes, quarterly advance tax outflows and  redemption of long-term repo operationscould result in a temporary inversion of the yield curve going ahead. Redemptions worth Rs 18,018 crore and Rs 61,131 crore are due in March and April, respectively. Banking System Liquidity Tightens G-sec Borrowing and Weighted Average Yields 


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