Comment

Liquidity to come under pressure in the coming weeks

Bond yields were under pressure last week with oil prices touching new highs and higher-than-expected domestic inflation for the third straight week. The hawkish inflation talk by the finance minister in Parliament also added to the nervousness.

Benchmark bond yields rose over 5bps with the 10-year benchmark bond yield closing higher by 5bps last week at the 7.64% levels, and the long bond — the 8.33%, 2036 bond — closing higher by 7bps at the 8.11% levels. Crude oil prices touched $110/bbl last week while inflation, as measured by the wholesale price index (WPI), came in at 5.11% against the market expectations of 4.99% for the week-ended March 1, 2008.

The positives were the improving liquidity outlook and the pledge by the finance minister to fund the farm loan waiver programme through government surpluses than through the issue of bonds.

The market was wary on liquidity in March due to year-end pressures and because the swap rates (overnight index swaps) were factoring high overnight borrowing rates with the one-month swap rate quoting over the 9% levels.

The fears eased when the Reserve Bank of India (RBI) announced two additional liquidity adjustment facility (LAF) auctions — one on March 14 and one on 17 to ease liquidity. The swaps came off at the short end on the announcements.

The market was also apprehensive of the funding of the agriculture loan waiver by the government. The finance minister has allayed the fears to a large extent. The market may see a short relief rally on the back of the positive news.

Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) of the RBI was easy with bids for reverse repo at 6% averaging around Rs 26,000 crore for the last week against Rs 4,400 crore seen in the week previous to last.

Overnight rates hovered around the reverse repo rate of 6%. Liquidity is likely to be under pressure in the coming weeks on account of advance tax outflows and overnight rates are likely to trend higher.

Government bonds
Government bonds saw yields rise week-on-week. The yield on the benchmark 10-year bond - the7.99% 2017 paper — was higher by 5bps to close at 7.64% levels.

The five-year benchmark bond yields was higher by 1bps with the yield on the 7.27%, 2013 bond closing at the 7.59% levels.

Yields on the long bond — the 8.33%, 2036 paper — closed higher by 8bps at the 8.13% levels.The ten-over-thirty spread closed higher by 3bps at the 49bps levels. Bond yields may rally, given the positive news on the funding of agricultural loans.

Treasury bills, corporate bonds and overnight index swaps
Treasury-bill (T-bill) yields were flat last week. The cut-off on the 91-day T-bill auction held on March 12 came in at 7.39% against a similar cut-offin the previous auction. The 364 day, T-bill auction saw the cut-off coming in at 7.44% against a cut-off of 7.55% in the previous auction. The RBI is auctioning 91-day and 182-day T-bills worth Rs 500 crore each this week.

Corporate bonds saw the curve flatten, with the short-end yields coming off, while the medium and long ends trended higher.

One-year yields came off by almost 30bps from highs as fears of liquidity eased and demand increased. Five-year benchmark yields were quoted around the 9.35% to 9.40% levels, up 5bps week-on-week.

Five-year AAA bond spreads were higher, at the 167 bps levels, by 4bps week-on-week. One-year yields are likely to drop further as supply dwindles amidst rising demand.

Overnight Index Swaps (OIS) saw the swap curve steepen from being inverted. The one-year OIS yield moved down by 10bps to close last week at the 7.01% levels, while the five-year OIS yields closed higher by 5ps at the 7.11% levels.
The short end of the curve moved down on easing liquidity conditions while the long end saw interest rate fears taking over. The one-over-five spread steepened from the negative 5bps levels to close at the positive 10bps levels. OIS yields are expected to track government bond movements this week.

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.