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The yield curve shifted upwards on the back of the higher-than-expected (in yield terms) auction cut-off on the benchmark five-year government bond. The Rs 8,000-crore auction of the benchmark bond, the 6.07% 2014, saw the cut off at 6.73%, which was 20 basis points (bps) over market expectations. The higher-than-expected cut-off helped pull up the yield curve to more comfortable levels.

The current levels of yields have priced in a lot of negatives in terms of government bond supply, higher global oil and commodity prices and higher global bond yields. The market is also bracing itself for the forthcoming budget where the government is expected to show a higher borrowing programme than the one indicated in the February 2009 vote on account.

The market will now watch factors such as advance tax numbers, movement in global bond yields, movement in oil prices and noises made on the budget. The advance tax numbers are likely to come in below estimates though there are positives in terms of higher direct tax collections for the period April-May 2009.

Global bond yields have been volatile on the back of worries of supply and inflation. The market will watch for signs of peaking of global bond yields given that economic data is not showing that much strength for inflation concerns. Oil prices are up almost 100% from lows and the market will watch for signs of peaking of oil prices.

Budget noises are made everyday — some positive (disinvestment) and some negative (third stimulus). Budget negatives are largely factored in at current levels of yields, while any positive will lead to a re-pricing of risk.

The Index of Industrial Production (IIP) growth numbers for April 2009 came in better than expected at 1.4% year-on-year increase, against expectations of a negative growth. The IIP growth, however, does not give much cause for comfort given that electricity showed higher growth on the back of higher prices paid by states during the elections. Manufacturing has lagged, indicating industrial growth is still anemic. Inflation as measured by the wholesale price index (WPI) came in above market expectations of 0.10% at 0.13% for the week ended May 30, 2009.

Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) auction of the Reserve Bank of India (RBI) remained high with bids for reverse repo crossing Rs 1,30,000 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 closing higher on the back of a weaker-than-expected auction cut-off on the five-year benchmark bond. The benchmark ten-year bond, the 6.05% 2019, saw yields move up 35 bps to close the week at 6.90% levels. The five-year benchmark bond, the 6.07% 2014, yield closed up 33 bps at 6.66% levels while the long bond, the 6.83% 2039, saw yields close 5 bps higher at 7.80% levels.

The government auctioned Rs 15,000 crore of bonds last week. The bonds auctioned were the 6.07% 2014 bond for Rs 8,000 crore, the 7.94% 2021 bond for Rs 3,000 crore, the 8.24% 2027 bond for Rs 2,000 crore and the 7.40% 2035 bond for Rs 2,000 crore. The cut-offs came in at 6.73%, 7.46%, 7.77% and 7.83%, respectively.

The government is auctioning Rs 15,000 crore of bonds this week. The bonds to be auctioned are the 6.49% 2015 for Rs 5,000 crore, the 6.35% 2020 for Rs 5,000 crore, a new 15-year bond for Rs 3,000 crore and the 7.50% 2034 for Rs 2,000 crore.

Treasury bills, corporate bonds and overnight index swaps (OIS)
Treasury bills (T-bills) yields were flat at the 91-day T-bill auction last week (June 10), with the cut-off coming in at 3.36%, little changed from the previous auction. The 182-day T-bill auction saw the cut-off at 3.59%, again little changed. 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 8.25% levels, up 15 bps week-on-week while ten-year benchmark bonds traded at 8.80% levels, up 15 bps week-on-week. Ten-year spreads closed down 22 bps at 178 bps levels while five-year spreads closed down 11 bps at 144 bps levels. Corporate bond yields are likely to track government bond yields in the coming week.

OIS saw the curve shift upwards on the back of the rise in government bond yields. The five-year OIS yield closed up 25 bps at 6.45% levels while the one-year OIS yield closed up 30 bps at 4.42% levels. The one-over-five spread moved down 5 bps to close at 203 bps levels. The OIS curve will take direction from movements in global bond yields.

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