Market will go bullish into monetary policy review

The bond market will go into the Reserve Bank of India (RBI) policy review on a bullish note. The markets will expect the RBI to maintain status quo on policy rates and also guide the market on its stance on liquidity. Ten year benchmark bond yields closed last week at 8.64% levels and in all likelihood will trend down further as the policy review date of December 16 approaches.

Bond yields rallied smartly last week on the back of RBI bond purchases and expectations of the central bank looking to soften its stance on inflation. The ten year benchmark bond the 8.79% 2021 bond saw yields fall by 17 bps week on week while the well traded 9.15% 2024 bond saw yields fall by 20 bps. The yield on the long bond, the 8.30% 2040 bond, fell 25 bps week on week.

The market took down yields at the longer end of the curve as it provided the most bangs for the buck in liquidity-starved market.
Bond traders prefer to build positions in long bonds when liquidity is tight and outlook on yields is bullish. The reason traders buy into the longer end of the curve in times of tight liquidity as long bonds offer higher leverage with less outlay of funds. Hence, the sharp rally in the 9.15% 2024 bond and the 8.30% 2040 bond.
The RBI auctioned a fresh 19 year maturity bond last week. The bid to cover ratio on the bond was five times i.e. the total bids received for the Rs3,000 crore auction was Rs15,000 crore.

The cut-off on the bond came in at 8.97% levels and the bond yield closed at 8.89% levels post auction. The high level of appetite shown by the market for this bond indicates the eagerness of traders in looking to build leverage using long bonds.

The long end of the curve will see a good amount of trading going forward with the darling of the markets being the 9.15% 2024 bond and the 8.97% 2030 bond. The yields on these bonds will come off from current levels of 8.79% and 8.89%, respectively.

Corporate bonds rallied on the back of rally in government bond yields. Five and ten year benchmark AAA rated corporate bond yields fell 10 bps each week on week, while five and ten year benchmark AAA credit spreads closed at 78 bps and 77 bps levels, respectively. Five year AAA credit spreads rose 12 bps week on week as the yield on the corresponding five year government bond fell more than the fall in five year corporate bond yield. Ten year AAA spreads rose by 5 bps week on week on the back of ten year government bond yields falling faster than the ten year corporate bond yields. Credit spreads will rise as government bond yields fall further.

The OIS (overnight index swaps) yield curve flattened last week with the five over one OIS spread flattening by 15 bps week on week. The five over one OIS spread, which is inverted, fell from negative 77 bps levels to negative 62 bps levels on the back of markets expecting the RBI to maintain status quo on rates in its policy review in mid December. The curve is likely to flatten further as the policy review date approaches.

Government bond auctions
The government auctioned Rs13,000 crore of bonds last week. The bonds auctioned were the 7.83% 2018 bond Rs4,000 crore, the 8.79% 2021 bond for Rs6,000 crore and a fresh 19 year bond for Rs3,000 crore. The cut offs came in at 8.67%, 8.71% and 8.97% respectively.

The RBI bought Rs5,780 crore of bonds last week through OMO (open market operations) purchase auctions. The bonds bought were the 7.99% 2017 bond for `649 crore at 8.63% yield, the 7.80% 2021 bond for Rs3,279 crore at 8.68% yield, the 8.08% 2022 bond for Rs1,267 crore at 8.72% yield and the 8.26% 2027 bond for Rs588 crore at 9% yield.

Arjun Parthasarathy is the editor of www.investorsare idiots.com,
a website for investors