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The rate cuts are expected before the policy review in January 2009. The ten-year benchmark bond yield fell below 6.10% (a multi-year low) last week. The bond, however, closed the week at 6.22% on the back of profit-taking at lower levels of yields. The OIS (overnight index swap) curve is trading below 5% levels indicating rate cuts ahead. The markets will continue to stay bullish till the event (rate cuts) occurs and the ten-year benchmark yield is likely to test 6% levels by the end of this month.
The rate cut expectations are justified by the pro-growth monetary policy stance of the RBI. The central bank has indicated that it will revise the GDP growth forecast for 2008-09. The RBI GDP growth forecast is currently at 7.5% (number revised from 8.5%) and it is worried about the effect of the global recession on India. Global economies are already in recession with Japan, Eurozone and US showing sharp fall in growth. The Reserve Bank will use monetary policy aggressively to minimise the impact of global recession on the country.
The IIP (index of industrial production) numbers for October 2008 came in at a negative 0.4% growth year-on-year. The number has fallen by 4.8% month-on-month. The IIP growth for the April-October 2008 is at 4.1% against 9.9% for the same period last year. Economists are predicting the IIP growth to print negative for the next couple of months given production cuts across sectors. The sharp slowdown in industrial production will have its bearing on RBI’s pro-growth monetary policy stance.
Inflation, as measured by the WPI (wholesale price index), came in at 8% for the week ended November 29, 2008. Inflation stood at 8.4% for the previous week. Inflation is expected to come off sharply in calendar 2009 on the back of sharp fall in commodity prices and sharp fall in prices of manufactured goods as producers cut prices in the face of sharp fall in demand. Economists are predicting inflation to print below 1% in 2009.
Liquidity was positive last week with bids for reverse repo at 6% touching Rs 38,000 crore. Overnight rates were trading in a 5% to 5.5% range after the revision of reverse repo and repo rates to 5% and 6.5% respectively. Liquidity is expected to be positive in the coming week though advance tax outflows may reduce the system liquidity.
Overnight rates are expected to be in the 5% to 6% band.
Government bonds
Government bonds saw yields move down week-on-week.The benchmark ten-year bond yield closed the week lower by 54 bps with the 8.24% 2018 bond closing the weekat 6.22% levels. The five-year benchmark bond the 7.56% 2014 bond closed down 43 bps week-on-week at 6.25% levels.The long bond the 7.95% 2032 bond yield moved down by 34 bps week on week to close at 6.95% levels. The ten-over-thirty spread steepened by 18 bps to close at 78 bps levels.
The government bought back Rs 10,000 crore of MSS (Market Stabilisation Scheme) bonds and held a government bond auction of Rs 10,000 crore last week.The government bought back Rs 5,000 crore of 5.87% 2010 MSS bond at a yield of 5.12% and Rs 5000 crore of 7.55% 2010 MSS bond at a yield of 5.49%. The last MSS buyback of the same bonds were at yields of 6.61% and 6.71% respectively.
The government auctioned 7.27% 2013 bond for Rs 6,000 crore and 7.50% 2034 bond for Rs 4,000 crore under the additional government borrowing programme. The cut-off came in better than market expectations at 6.24% and 6.99% respectively.
Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were lower in the auction last week with the cut-off on the 91 day T-bill auction held on December 10 coming in at 5.65% against a cut-off of 6.60% seen in the previous week.The 182-day T-bill auction saw the cut-off coming in at 5.61% against a cut off of 7.06% seen in the previous auction. The RBI, this week, is auctioning Rs 5,000 crore of 91-day T-bills and Rs 1,000 crore of 364-day T-bill under regular auction.
Corporate bonds saw good activity on the back of sharp fall in government bond yields. Ten-year benchmark AAA spreads fell 63 bps to close at 265 bps levels while five-year benchmark AAA spreads moved down 75 bps to 300 bps levels. The market is giving higher premium to bonds issued by public sector undertakings. Five-year IRCF bonds are trading at 9% levels while five-year Reliance bonds are trading at 9.80% levels. The spreads will remain wide given the concerns of economic slowdown in the corporate sector. Primary issues are hitting the market as corporates look to borrow at lower yields on the back of falling government bond yields.
Overnight index swaps (OIS) saw the curve fall on rate-cut expectations. The one-year OIS yield moved down by 25 bps to close at 4.70% levels while the five-year OIS yield closed down 53 bps at 4.87% levels The one-over-five spread flattened by 27 bps to close at 17 bps levels. The OIS curve is factoring in rate cuts and the curve will stabilise at current levels.
Disclaimer: The author is senior fund manager - fixed income IDFC Mutual Fund and views are personal