Bond yields set to continue their upward march

Government bond yields will continue with their upward march on the back of PM inflation speak, rise in US treasury yields and easing liquidity conditions.

Bond yields rose around 10 basis points week on week on the back of fresh selling by traders, with the most traded bond the 8.13% 2022 bond seeing yields rising to 8.26% levels from levels of 8.15% seen in the week previous to last.

The market is going into this week with interest rate negative weekend news and that should filter into auction cut-offs on the Rs10,000 crore bond auction scheduled for this week.

The Prime Minister spoke tough on inflation last week saying that persistent inflation can kill economic growth. The RBI is the only entity that can actually act on inflation as the government does not have the political will to take tough decisions. The market will perceive the PM’s remark as inter-policy rate hikes to take up bond yields.

Yields on US treasuries rose over 30 bps week on week on the back of better-than-expected economic data. The drop in US unemployment rate to 9% from 9.4% after the economy added 36,000 jobs in January 2011 pushed up bond yields to an eight-month closing high. The market will start discounting the US Federal Reserve moving away from its unprecedented accommodative policy earlier than expected leading to a sharp rise in treasury yields.

System liquidity eased Rs25,000 crore last week on the back of government spending and bond redemptions. The market borrowed Rs73,000 crore from the RBI against Rs100,000 crore seen in the week previous to last on a daily average basis.

Further easing of liquidity will enable RBI to carry out its monetary tightening at the pace it desires.

The government borrowing programme for the fiscal 2010-11 is scheduled to end with the `10,000 crore auction scheduled for this week. The market, however, can expect another `10,000 crore auction which will make up for auctions that were reduced in size due to tight liquidity conditions.

Primary article inflation came in at 18.44% for the week ended January 22, 2011, with both food and fuel index inflation moving up. Food price inflation came in at 17.05% against 15.57% seen in the previous reading while fuel price inflation came in at 11.61% against 10.87% seen in the previous reading.

Food price inflation can get a respite with the recent fall in vegetable prices but fuel price inflation is still understating fuel price rise by a wide margin due to subsidies.

Global oil prices are trading at over two-and-a-half year highs while commodity prices including copper and other metals are trending higher on better than expected global economic data.

Interest rate swap yields moved higher last week on the back of rising bond yields. The one-year OIS (Overnight Index Swaps) yield moved higher nine bps week on week while the five-year OIS yield moved up 14 bps. Five-year OIS yield at 8.08% will rise further to catch up and exceed the five-year government bond yield which is at 8.16% levels.

Corporate bond yields rose on the back of rising government bond yields. Five-year corporate bond yields rose seven bps week on week while ten-year bond yields rose three bps. One-year money market credit yields remained unchanged at 9.90% levels. The curve will see flattening as five- and ten-year yields rise to catch up with yields at the short end.

Government bond auction
The government auctioned Rs10,000 crore of bonds last week. The bonds auctioned were the 7.17% 2015 bond for Rs3,000 crore, the 8.13% 2022 bond for Rs4,000 crore and the 8.30% 2040 bond for Rs3,000 crore. The cut-offs came in at 8.17%, 8.23% and 8.58%, respectively.

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