Comment

The government has announced a dated bond auction for Rs 6,000 crore to be held on July 24. The auction is as per the borrowing calendar for the first half of this fiscal. There are, however, changes in the auction details that will set the tone for bond markets this week.

The government is auctioning 10-year bonds as against the 15-to-19-year maturity bonds as given in the calendar. The government is also holding a uniform-price auction as against the standard multiple-price auction. In a uniform-price auction, all bidders receive the same price, while in a multiple-price auction the bidders receive the price they have bid for.

The auction changes hold significance, with finance ministry sources saying they expect hikes in the cash reserve ratio (CRR) and repo rate in the first quarter review of the Reserve bank of India’s (RBI) annual monetary policy on July 29.

The market will debate on the significance of the changes. On the negative side, the changes could be seen as the government not wanting to saddle the market with illiquid, longer dated bonds ahead of tough policy actions.

On the other hand, the change could be interpreted as the government wanting to pay market price for its borrowings as against paying higher prices on off-the-run bonds, as seen in the last auction of 8.28% 2032 bond where the cut-off came in at 10.02% as against the yield-curve price of 9.65%.

The sharp rally in the oversold market last week on the back of falling oil prices, lower-than-expected inflation numbers and the finance ministry speak late on Friday will play a large part in the interpretation of the auction.

The rally, coupled with more after-market speak by the finance ministry, will be taken as an opportunity for negative interpretation. The finance ministry had during market hours indicated that CRR hike and not repo rate hike was expected in the policy, but media channels reported after market hours that CRR and repo rate hikes were expected.

Oil prices fell on demand concerns and a stronger US dollar. Benchmark crude prices fell from highs of $145/bbl to $128/bbl last week. The US dollar strengthened on expectations of rate hikes by the US Federal Reserve. Ten-year yields rose 18 basis points (bps) from the week’s lows to close at 4.08% levels on inflation and rate hike sentiments. Inflation as measured by the Wholesale Price Index came in at 11.91% for the week ended July 5, as against market expectation of 12.05%.

Liquidity as measured by bids for reverse repo or repo in RBI’s liquidity adjustment facility was tight last week, with bids for repo at 8.50% in the range of Rs 25,000 crore to Rs 45,000 crore. Overnight rates traded around repo levels of 8.5% on the back of tight liquidity. Liquidity is expected to remain tight given the kicking in of a 25 bps CRR hike this fortnight, which will suck out Rs 8,000 crore of liquidity from the system and on the back of auction outflows of Rs 10,500 crore. Overnight rates are likely to hover around repo levels of 8.5%.

Government bonds
Government bonds saw yields fall sharply as the market bought aggressively on the back of a sharp fall in oil prices. The benchmark ten-year bond yield closed lower by 37 bps week-on-week with the 8.24% 2018 bond closing the week at 9.09% levels.

Five-year benchmark bond yields were lower by 22 bps with the yield on the 7.27% 2013 bond closing at 9.30% levels. Yields on the long bond, the 8.33% 2036 bond, closed lower by 12 bps at 9.63% levels. The yield curve is inverted as the ten-year benchmark is traded aggressively given the liquidity in the bond, while other bonds, across the curve, are finding price discovery difficult.

Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were higher last week on the back of tight liquidity. The cut-off on the 91-day T-bill auction held on July 16 came in at 9.11% against a cut-off of 9.02% seen in the previous auction. The 364-day T-bill auction saw the cut-off coming in at 9.45% against a cut-off of 9.17% seen in the previous auction.

This week, the RBI is auctioning Rs 3,000 crore of 91-day T-bills of which Rs 500 crore is under regular auction and Rs 2,500 crore is under the Market Stabilisation Scheme and Rs 1,500 crore of 182-day T-bills of which Rs 500 crore is under regular auction and Rs 1,000 crore is under MSS.

Corporate bonds saw yields steady at higher levels, and did not participate in the rally by the government bonds. Five-year bonds were trading flat at 10.70% to 10.80% levels, while short-end yields were pressured on supply. One-year bonds were traded in the 10.80% to 11% range. Credit spreads moved higher by 18 bps to close the week at 123 bps levels as government bond yields fell. Corporate bond yields will see the demand-supply balance keeping yields sticky at higher levels.

Overnight Index Swaps (OIS) saw the curve come off sharply on the back of the rally in government bonds. One-year OIS yields moved down by 25 bps to close last week at 9.52% levels, while five-year OIS yields closed lower by 44 bps at 9.52% levels. The five-over-one OIS spreads inverted by 19 bps to close flat. The spread can invert further if the market expects a hike in CRR.

Disclaimer: The author is senior fund manager - fixed income, IDFC Mutual Fund. Views are personal.