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ShareSentiment in the bond market is set to improve with the last government bond auction going through smoothly. The auction of Rs 12,000 crore of bonds saw cut-offs coming in better than expectations with increased participation from market participants.
The auctioned bonds traded better in yield terms after the cut-offs, indicating that the market demand was not fully met. The choice of stock for the Rs 11,000 crore auction this week is positive for the market.
The auction stock -- the 7.40% 2012 bond -- is a couple of years lower in maturity from the scheduled five years and higher tenured than maturity stocks, indicating that the Reserve Bank of India wants to give the market some respite in terms of maturities.
The successful completion of this week's auction will take away a large part of supply pressures in the market. On completion of Rs 3 lakh crore of gross borrowing in September, the borrowing halves in the second half of 2009-10.
The level of yields in the market is another factor which is likely to improve the risk-taking ability of market participants. 10-year benchmark bond yields are at 11-month highs at 7.45%. The high levels of yields has factored in a host of negatives including large government bond supply, higher inflation expectations and expected withdrawal of accommodative policy by the RBI.
The market may slowly come to believe that yields may not go up much further from here, thereby reducing downside risks in terms of prices.
The global environment is favouring the market at present. Eurozone and US employment is at 9.7% levels and this is likely to keep central banks from raising rates in the near future.
Domestic inflation is a worry for markets with primary article inflation trending at double-digit levels. Inflation expectations are rising on the back of rising primary article inflation. The RBI is likely to use liquidity tools to bring down inflation expectations. The RBI may raise the cash reserve ratio to bring down system liquidity.
However, a hike in CRR will only bring liquidity back to normal levels and may not impact markets much. The RBI may also raise the statutory liquidity ratio as a liquidity measure which also serves the purpose to give banks enough headroom to buy government bonds in their held-to-maturity portfolios.
Inflation as measured by the wholesale price index (WPI) came in at negative 0.21% for the week ended August 22, 2009, against expectations of -0.85%. The high base effect may wear off sooner than expected on sustained rise in primary article inflation.
Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility auction of the RBI remained high with bids for reverse repo crossing Rs 1.5 lakh crore. Overnight rates were at 3% levels. Liquidity will continue to be high in the system keeping overnight rates low.
Government bonds
Government bonds saw yields move up week-on-week on fears of inflation and bond supply. The 10-year benchmark bond, the 6.90% 2019 bond, saw yields move up by 11 basis points to close the week at 7.45% levels. The five-year benchmark bond -- the 6.07% 2014 security -- saw yields move up by 15bps to close at 7.23% levels. The 7.94% 2021 bond saw yields move down by 5bps to close at 7.93% as market bought into attractive yields, while the long bond, the 8.24% 2027 note, saw yields close up 3bps at 8.16% levels.
The government auctioned Rs 12,000 crore of bonds last week. The bonds auctioned were the 6.49% 2015 bond for Rs 5,000 crore, the 6.90% 2019 bond for Rs 5,000 crore and the 8.24% 2027 bond for Rs 2,000 crore. The cut-offs came in at 7.45%, 7.50% and 8.19% respectively.
The government is scheduled to auction Rs 11,000 crore of bonds this week. The bonds to be auctioned are the 7.40% 2012 bond for Rs 5,000 crore, the 6.35% 2035 bond for Rs 4,000 crore and the 8.28% 2032 bond for Rs 2,000 crore.
The RBI purchased Rs 2,231 crore of bonds in the open market operations (OMO) purchase auction last week. The bonds bought were the 7.38% 2015 bond for Rs 1,160 crore, the 8.24% 2018 bond for Rs 626 crore and the 7.95% 2032 bond for Rs 445 crore. The cut-offs were 7.31%, 7.49% and 8.14%, respectively.
Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were flat in the 91-day T-bill auction held last week, with the cut-off on the 91-day T-bill auction held on September 2 coming in at 3.40%, against a similar cut-off seen in the previous auction.
The 182-day T-bill auction saw the cut-off coming in at 3.99% against a cut-off of 3.93% in the previous auction. The RBI is auctioning Rs 5,000 crore of 91-day T-bills and Rs 1,500 crore of 182-day T-bills this week.
Corporate bond yields were flat week-on-week as the market saw bidding interest at higher levels. Five-year benchmark bonds traded at 8.50% levels while 10-year benchmark bonds traded at 8.85% levels. Five-year spreads closed at 113bps levels while 10-year spreads closed at 127 bps levels, down 15bps and 9bps respectively. Credit spreads came off on the back of higher government bond yields. Corporate bond yields are likely to remain sticky at current levels with spreads moving on the back of government bond yield movement.
Overnight index swaps (OIS) saw the curve flatten week-on-week. The five-year OIS yield closed lower by 2bps at 6.42% levels while the one year OIS yield closed higher by 5bps at 4.49% levels. The one-over-five spread came off by 7bps to close at 193bps levels. The OIS curve is likely to flatten further as market looks to receive the spread on the back of attractive spread levels.
Disclaimer: The author is head, fixed income, IDFC Mutual Fund. Views are personal
