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ShareThe bond market is worried. But what it is worried about is a mystery.
The worry shows in the volumes where even the benchmark ten-year paper traded very thin volumes. The low volumes are feeding into nervous auction bids and cut-offs are coming in higher in yield terms.
The last government bond auction saw the cut-off on the 6.35% 2020 paper and the 7.35% 2024 paper coming in at 40 bps higher than levels seen a month ago. The bid-to-cover ratio has come down from over 2x to around 1.5x, indicating weakening demand for government paper. The situation is self-fulfilling, with low market volumes making auction positions difficult to offload, leading to even weaker bids in the next auction. Unless the Reserve Bank of India (RBI) steps in to improve sentiments, the government will struggle to complete the remaining Rs 70,000 crore of borrowing slated for the first half of this fiscal.
The market worry on rates is despite positive factors surrounding the interest rate environment.
Government borrowing will be two-thirds complete by end-September and government finances are in a much better shape than they were in the beginning of the fiscal. The government has not drawn down its overdraft with the RBI for over a month and with advance tax inflows in September, it will be able to meet all its commitments without straining its finances. The recent success of the NHPC IPO is a good indicator for further offerings, which will improve inflows into the government coffers.
Global indicators have also been positive, with bond yields facing high resistance at higher levels. Global bond yields have come off almost 30 bps from highs seen in the past few weeks. Oil prices, which are an indicator of inflation expectations, have faced high resistance at higher levels, implying underlying demand worries. Oil prices have come off from over $70/bbl to $67/bbl levels over the last few days.
Domestic credit is yet to pick up, with credit growth at 15.8% year on year against RBI target of 20%. Deposit growth has been healthy at 21.8% year on year and broad money supply at 20% year on year is at the higher end of the RBI target. Good deposit growth coupled with good liquidity and weak credit growth is positive for government bonds.
The ball is now firmly in RBI's court to improve market sentiments. The apex bank has indicated that it will maintain an accommodative policy stance until the growth outlook clears and will make sure government borrowing goes through smoothly using all its policy tools including bond purchases through open market operations (OMO). The RBI governor said in a recent speech that food price inflation is outside the policy ambit as it is a supply side issue and weak monsoons driving up food prices cannot be controlled by interest rate measures. In fact, any negative interest rate action on the back of higher food prices will mean taking the economy sharply down the growth path, which is going against RBI's current policy stance. The RBI still has Rs 40,000 crore of outstanding OMO purchases left and it can put this to good use in the remaining few weeks of the first half of the fiscal.
The RBI can also advise the government on keeping its options open for the Rs 12,000 crore auctions, which did not go through due to bank strike, till the last week of September. Increasing auction sizes to Rs 15,000 crore in the current scenario is not a positive signal for a nervous market.
The RBI can also intervene directly in the market and take out auction stock from traders desperate to create space for forthcoming auctions.
Inflation as measured by the wholesale price index came in at negative 1.74% for the week ended August 1, 2009. Inflation is likely to stay negative in the coming weeks on the back of high base effect.
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 crossing Rs 1.3 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 the back of higher auction cut-offs in terms of yields. The ten-year benchmark bond, the 6.90% 2019 bond, saw yields move up 7 bps to close the week at 7.10% levels. The five-year benchmark bond, the 6.07% 2014 bond, saw yields move up 2 bps to close at 6.84% levels, while the well-traded 7.94% 2021 bond saw yields move up by 4 bps to close at 7.51%, respectively. The long bond, the 7.40% 2035 bond, saw yields move down 5 bps to close at 8.02% levels. The government auctioned Rs 12,000 crore of bonds last week. The bonds auctioned were a new seven-year bond for Rs 6,000 crore, the 6.35% 2020 bond for Rs 4,000 crore and the 7.35% 2024 bond for Rs 2,000 crore. The cut-offs came in at 7.02%, 7.45% and 7.77%, respectively.
Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were higher in the 91-day T-bill auction held last week with the cut-off on the 91-day T-bill auction held on August 12, 2009 coming in at 3.38% against a cut-off of 3.28% seen in the previous auction. The 364-day T-bill auction saw the cut-off coming in at 4.10% against a cut-off of 3.80% seen in the previous auction. The RBI is auctioning Rs 5,000 crore of 91-day T-bills and Rs 1,500 crore of 364-day T-bills this week.
Corporate bond yields were almost flat week on week as yields turned sticky at higher levels. Five-year benchmark bonds traded at 8.25% levels, while the ten-year benchmark bond traded at 8.75% levels. Five-year spreads closed at 130 bps levels while ten-year spreads closed at 152 bps levels. Corporate bonds will track gilt yield movements this week.
Overnight index swaps (OIS) saw the curve almost unchanged week on week. The five-year OIS yield closed flat at 6.43% levels, while the one-year OIS yield closed at 4.45% levels. The OIS curve will also take its cue from gilt yield movements this week.
The author is head - fixed income, IDFC Mutual Fund. Views are personal.
