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Volatility Collapsing in India as Highest Asian Yields Draw Cash

(Bloomberg) -- Indian bonds are offering two rarities for investors in global markets still reeling from the U.K.’s decision to quit the European Union: high yields and a stable currency.

Expectations for rupee swings have dropped at the fastest pace in Asia since Britain’s June 23 vote amid the biggest inflows into Indian notes since October. Foreigners are returning to rupee debt after a two-month hiatus as strong monsoon rains help ease concern about inflation, boosting the allure of securities that offer the highest 10-year sovereign yield among major Asian markets.

“India has attracted strong foreign investor inflows following Brexit due to its high yield,” said Khoon Goh, head of Asia research in Singapore at Australia & New Zealand Banking Group Ltd. “It is also seen as less directly affected by any downside effects from Brexit due to its low reliance on exports. The inflows have helped to keep rupee volatility low.”

Overseas ownership of Indian government and corporate notes has increased by 67.8 billion rupees ($1 billion) so far in July, with holdings rising for 10 straight days through Wednesday in the longest stretch since February 2015, National Securities Depository Ltd. data show. They dropped by 120 billion rupees in the previous two months as inflation accelerated and anxiety over the Brexit vote sapped demand for emerging-market assets. Local stocks have lured inflows of $1.06 billion this month.

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The rupee’s one-month implied volatility, used to price options, has slumped 131 basis points since June 23 to 5.51 percent in Mumbai on Monday, data compiled by Bloomberg show. That’s the period’s biggest decline in Asia. In the spot market, the currency has strengthened 0.3 percent in July to 67.3525 a dollar, after three months of declines.

Neuberger Berman Group LLC is overweight Indian bonds given the nation’s faster economic growth, the potential for reforms and high yields, according to Prashant Singh, the Singapore-based lead portfolio manager for Asian emerging debt at the firm, which oversees $250 billion globally.

A revival in seasonal showers has sparked gains in sovereign bonds this month, with the 10-year yield sliding 20 basis points, the most since September, to 7.25 percent on Monday, its lowest close since June 2013. That’s still 567 basis points more than what similar-maturity Treasuries pay. Speculation that a successor to Reserve Bank of India Governor Raghuram Rajan will be more dovish has contributed to the rally in debt.

“The attractiveness of nominal yields, especially when viewed in comparison to regional and global peers, argues in favor of onshore bonds in India,” said Singh. “While inflation trajectory is a concern, we feel comforted by the steady improvement in monsoons which should lead to some easing in food price pressures.”

While Brexit presented a new concern for global markets, investors are also bracing for an increase in U.S. interest rates. The probability of a move by the Federal Reserve this year has risen in the past few days as recent economic data signaled improvements in the world’s largest economy.

“I expect the rupee to be insulated to some extent, but it will not be immune to wider swings in the dollar,” said ANZ’s Goh. “Yield support will help the currency, but further reform progress by the government and confirmation of the new RBI governor will be closely watched.”

To contact the reporters on this story: Nupur Acharya in Mumbai at nacharya7@bloomberg.net, Kartik Goyal in Mumbai at kgoyal@bloomberg.net. To contact the editors responsible for this story: Garfield Reynolds at greynolds1@bloomberg.net, Arijit Ghosh at aghosh@bloomberg.net, Shikhar Balwani

©2016 Bloomberg L.P.