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The bond market last week shrugged off a host of negatives to bid at the curve for the Rs 10,000 crore auction held last week.

The market showed resilience in the face of a higher than expected index of industrial production (IIP) growth number for September, uncertainty on 3G auction schedule, higher global commodity prices on the back of a weakening dollar and the release of the first monthly wholesale price index (WPI) on Saturday on November 14.

The IIP year-on-year growth for September came in at 9.1%, against market expectations of 7.1% indicating higher industrial activity on the back of growing domestic demand. The 3G auction scheduled to be held in January 2010, which is expected to raise Rs 35,000 crore for the government, is facing uncertainty on the back of issues on spectrum availability.

On the global front, the US dollar weakened against majors taking commodity indices to close to one year highs. The monthly WPI was scheduled for release on November 12 but was deferred to November 14. A mid-week release of the number would have removed inflation uncertainty in the market but a Saturday release adds to worries on carrying overnight positions especially after a bond auction. The fact that the market bid at the curve for the Rs 10,000 crore auction in the face of uncertainty suggests that the market is looking at bullish times ahead.

The reason for market optimism is not apparent given that inflation expectations are rising, the Reserve Bank of India (RBI) is expected to commence policy tightening sooner than later and government finances may weaken further if the 3G auction does not go through.
However, demand in bond auctions is rising and supply is lower in the coming months. Bank credit growth which is anaemic at below 10% is also seen a factor in boosting government bond demand as deposit growth is at 19% levels and system liquidity is high at over Rs 1,00,000 crore.

Risk appetite is also coming back into the system as improving market conditions and reducing volatility increases risk limits in the system. The short-term bullishness may hold sway over medium-term negatives leading to a healthy rally in bond yields.

Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) auction of the RBI remained high with bids for reverse repo at around Rs 1,00,000 crore. Overnight rates were at 3% levels and are likely to remain at 3-3.25% levels given high system liquidity.

Government bonds
Government bonds saw ten-year yields close flat week-on-week. The ten-year benchmark 6.90% 2019 bond saw yields close the week unchanged at 7.32% levels. The new five- year benchmark bond, the 7.32% 2014 bond saw yields move down by 3 basis points (bps) to close at 7.06% levels. The 6.35% 2020 bond saw yields close flat at 7.71% levels while the long bond the 8.24% 2027 bond saw yields close up 7 bps at 8.25% levels.

The government auctioned Rs 10,000 crore of bonds last week. The bonds auctioned were the 7.02% 2016 bond for Rs 3,000 crore, the 6.90% 2019 bond for Rs 4,000 crore and the 8.24% 2027 bond for Rs 3,000 crore. The cut-offs came in at 7.36%, 7.34% and 8.28% respectively.

The government is scheduled to auction Rs 10,000 crore of bonds this week. The bonds to be auctioned are the 7.32% 2014 bond for Rs 3,000 crore, the 6.35% 2020 bond for Rs 4,000 crore and the 7.50% 2034 bond for Rs 3,000 crore.

Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bills) yields were flat in the 91 dayT-bill auction held last week with the cut-off on the 91-day T-bill auction held on November 11, 2009, coming inat 3.27% against a similar cut-off of seen in the previous auction.

The 182-day T-bill auction saw the cut-off coming in at 3.82% against a cut-off of 3.97% seen in the previous auction. The RBI is auctioning Rs 7,000 crore of 91-day T-bills and Rs 2,000 crore of 364-day T-bills this week.

Corporate bond yields were lower week-on-week, on the back of liquidity-driven buying. Five-year benchmark bonds traded at 8.3% levels while ten-year benchmark bonds traded at 8.65% levels down 6 bps and 12 bps, respectively. Five-year spreads closed lower by 3 bps at 111 bps levels while ten-year spreads closed lower by 12 bps at 120 bps levels. Corporate bond yields at the long end may remain bid given lack of supply and steady demand from investors.

Overnight index swaps (OIS) saw the curve shift up week-on-week on the back of prospects of RBI rate hikes. The five-year OIS yield closed higher by 7 bps at 6.69% levels while the one year OIS yield closed higher by 11 bps at 4.73% levels.
The one-over-five spread closed lower by 4 bps at 194 bps levels.

The curve is likely to flatten further given the prospects for rate hikes and liquidity-sucking measures by the RBI pressurising the short end of the curve. The steepness of the curve will prevent sharp hikes in yields at the longer end of the curve.

Disclaimer: The writer is head, fixed income, IDFC Mutual Fund. Views are personal.