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ShareThe Reserve Bank of India did not give what the market wanted, in terms of a higher cut-off of yields, in the government bond auction held last week.
The bond auction for Rs 12,000 crore saw the RBI rejecting all bids. The market had gone into the auction expecting devolvement on the 10-year paper on the primary dealers at around 7.15% levels. 10-year yields at 7.15% levels was last seen in March 2009, where the RBI had intervened aggressively in the form of higher bond purchases and rejected auction bids to bring down yields. The RBI has once again acted to keep yields from going higher as stated in their monetary policy objective of running the government borrowing smoothly without disruptions in yields.
The signal sent out by the RBI in rejecting auction bids will cap yields from going higher in the near term.
The RBI, in its endeavour for effective pass-through of accommodative monetary policy in the face of large government borrowing, is helped by comfortable government finances and bond purchase balances. The government, as of July 31, was in surplus with the RBI for Rs 10,000 crore and bond purchase balance of the RBI is at Rs 40,000 crore.
Government finances are expected to get better in the next two months on the back of dividends, advance tax and stake sale proceeds. The RBI can intervene aggressively if necessary to comfort jittery markets.
The two-day bank strike had affected markets last week with volumes dipping and on expectations that nationalised banks will not participate in the government bond auction.
The market had gone short into the auction, with the 10-year bond sold aggressively by traders expecting to cover at higher yields in the auction. 10-year bond yields had touched highs of 7.15% on higher yield cut-off expectations.
The choice of bonds for the Rs 12,000 crore auction this week will go against the shorts with the auction stocks being a fresh 7-year bond and reissue of6.35% 2020 and 7.35% 2024 bonds. The market will see short covering by traders, helping the 10-year bond yield to move down.
Inflation as measured by the wholesale price index came in at negative 1.58% for the week ended July 25, 2009 against expectations of -1.50%. 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 auction of the RBI remained high with bids for reverse repo crossing Rs 1.2 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 bank strike and worries on auction cut-offs. The 10-year benchmark bond, the 6.90% 2019 security, saw yields move up by 3 basis points to close the week at 7.03% levels. The five-year benchmark bond, the 6.07% 2014 bond, saw yields move up by 8bps to close at 6.82% levels, while the well-traded 7.94% 2021 bond saw yields move up by 11bps to close at 7.47%. The long bond -- the 7.40% 2035 note -- saw yields move up by 20bps to close at 8.07% levels.
The RBI purchased Rs 2,958 crore of bonds through open market operations last week. The bonds purchased were the 7.38% 2015 bond, the 6.05% 2019 bond and the 7.95% 2032 bond at yields of 6.95%, 7.09% and 7.89%, respectively.
The government is auctioning Rs 12,000 crore of bonds this week. The bonds to be auctioned are 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.
Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) 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 5, 2009, coming in at 3.28%, against a cut-off of 3.20% seen in the previous auction.
The 182-day T-bill auction saw the cut-off coming in at 3.76% against a cut-off of 3.47% seen in the previous auction. The RBI is auctioning Rs 5,000 crore of 91-day T-bills and Rs 1,000 crore of 364-day T-bills this week.
Corporate bond yields were higher week-on-week on the back of higher government bond yields. Five-year benchmark bonds traded at 8.20% levels, up 5bps week-on-week, while 10-year benchmark bonds traded at 8.78% levels, up 10bps week-on-week. Five-year spreads closed lower by 8bps at 122bps levels, while 10-year
spreads closed higher by 7bps at 157bps levels. Corporate bond spreads are likely to move up on the back of worries on liquidity over the next couple of months.
Overnight index swaps saw the curve flatten week-on-week on the back of worries of liquidity tightening. The five-year OIS yield closed up 8bps at 6.43% levels while the one year OIS yield closed up 14bps at 4.42% levels. The one-over-five spread flattened by 6bps to 200bps levels. The OIS curve is likely to flatten further as markets frets on liquidity.
Disclaimer: The author is head-fixed income, IDFC Mutual Fund. Views are personal.
