Sans excitement, bond market living it from OMO to OMO

The bond market, for want of anything better to do, is content with buying bonds from the secondary market to give to the Reserve Bank of India (RBI) in the OMO (open market operation) purchase auctions.

The central bank has been buying on-the-run bonds through OMO purchases at below secondary market traded yields.

It is keen on filling the auction amounts of Rs12,000 crore to infuse liquidity into the system. There are two more OMO auctions to go for amounts of Rs12,000 crore each and the players will look to tender bonds purchased in the secondary market to the RBI at lower yields to make slight arbitrage profits.

Participants will not go overboard in carrying out this arbitrage as there are three or four stocks in each OMO and RBI may just clear ones that are closest to secondary market yields, leaving arbitrageurs with unsold bonds.

The market is not at all enthusiastic about the bond purchases.
The central bank bond buying is preventing bond yields from rising due to issues of inflation and supply.

The government is steadfastly refusing to bring down the size of the total borrowing for the year 2010-11 despite parking Rs106,000 crore with the RBI.

The market does not want more supply given the distorted yield curve, falling deposit growth (14.6% year on year) against rising credit growth (23.7% year on year) and rising inflation expectations (primary article inflation has gone up to 17.3% year on year while an impending diesel price hike is likely to push up fuel inflation).

Secondary market traded volumes in the government securities market is below Rs5,000 crore on a daily average basis indicating the market’s discomfort with current levels of bond yields.

The government resumes its borrowing this week with a scheduled Rs11,000 crore auction.

The market may expect a new ten year benchmark given that the RBI is buying the old ten year benchmark, the 7.80% 2020 bond, in the OMO auctions.

Bond yields will rise in the government bond auctions while the OMO purchases are likely to see cut-offs at lower yields.
Liquidity continues to be tight with average bids for repo at 6.5% in the LAF (Liquidity Adjustment Facility) auction at around Rs122,000 crore.

Liquidity will continue to remain in deep negative territory despite RBI bond purchases as the government is not likely to spend the Rs106,000 crore parked with the RBI anytime soon.

Banks are in need for liquidity given that the incremental credit deposit ratio is trending well over 100%. Money market rates will continue to trend higher especially in the credit curve.

The credit curve will continue to remain inverted given the banks need for funds at the short end of the curve. Commercial paper rates and certificate of deposit rates are likely to trend sharply higher from current levels.

Government bond auction
There were no government bond auctions held last week. However, the RBI purchased Rs11,500 crore of bonds during the week. These were the 7.02% 2016 for Rs524 crore at a yield of 7.79%, the 7.99% 2017 for Rs3,124 crores at a yield of 7.78%, the 8.13% 2022 for Rs5,437 crore at a yield of 7.99% and the 8.26% 2027 for Rs2,416 crore at a yield of 8.32%.

Email: arjun@arjunparthasarathy.com
URL: www.arjunparthasarathy.com
Blog: parthasarathyarjun.wordpress.com