Comment

Yields may soften 10 bps on build-up of momentum

MUMBAI: The bond market received two major news on Friday last, which lifted up sentiments and can potentially lead to a healthy rally in prices this week. The first was the finance minister’s statement where he hoped that interest rates in the economy can come down. The second was the US non-farm payroll report that saw less jobs being created and unemployment trending higher.

The FM speak came during market hours and led to a healthy 7 bps rally in bonds and 20 bps rally in swaps.

The US payroll report increases the probability of a rate cut by the US Federal Reserve (Fed) in their policy meet at the end of this month. The US payroll report also brought down equity markets across the globe and further falls in equity prices would mean a US hard landing leading to slower growth across all economies.

The domestic bond market will look to play for a neutral-to-softening stance by the Reserve Bank of India (RBI) if further data points to a global economic slowdown. Traders will tend to take the market up on hopes of positive interest rate environment in the near-term.

Bond yields fell around 10 bps across the curve week-on-week with the ten-year benchmark bond closing the week at 7.70% levels from 7.80% levels seen in the week earlier to last.

Interest rate swaps yields fell with the five-year swap yield falling 24 bps week-on-week. US treasury yields fell with benchmark ten-year treasury yield falling 20 bps week-on-week to close at 3.87% levels. Domestic bonds may see yields soften by 10 bps this week as traders build up momentum.

The RBI has reintroduced MSS (market stabilisation scheme) auctions this week on the back of increasing system liquidity.

The RBI is auctioning
Rs 3,500 crore of Treasury Bills under MSS this week to suck out liquidity. The RBI is also auctioning Rs 10,000 crore of government bonds under the government borrowing programme and Rs 5,800 crore of state loans for different states.

The auctions should be well bid given good liquidity and positive interest rate sentiments.

Inflation as measured by the WPI (wholesale price index) came in higher than expected at 3.50% for week ended December 22, 2007. Market expected inflation to come in at 3.43% levels.

Credit growth was at 22.2% and broad money growth was at 22.8% as of December 21, 2007. Credit growth is close to RBI’s fiscal year end targets while money supply is trending higher than RBI’s comfort zone.

Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI saw bids for reverse repo at 6% touching Rs 40,000 crore during the week.

Liquidity which was negative in the week before last went into positive on government spending, special deposit scheme inflows and redemption of bonds. Overnight rates fell sharply to below 6% on ample liquidity. Liquidity is expected to be easy this week though large equity offers may create demand for funds in the second half of the month.

Government bonds
Government bonds saw yields fall across the curve. The yield on the benchmark ten-year bond 7.99% 2017 bond was lower by 12 bps to close at 7.70% levels. Five-year benchmark bond yields was down 10 bps with the yield on the 7.27% 2013 bond closing at 7.56% levels. Yields on the long bond, the 8.33% 2036 bond closed lower by 10 bps at 8.06% levels.

The RBI is auctioning Rs 10,000 crore of government bonds under the government borrowing programme on January 11.

The bonds to be auctioned are the 7.99% 2017 bond for Rs 6,000 crore and the 8.33% 2036 bond for Rs 4,000 crore. The auction is expected to be well bid with interest from across the market segment.

Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were lower last week on good liquidity. The cut off on the 91 day T-bill auction held on January 2 came in at 7.02% against 7.35% cut-off seen in the previous auction. The 364-day T-bill auction saw the cut-off coming in at 7.39% against 7.66% cut-off seen in the previous auction. The RBI is auctioning Rs 3,500 crore of 91-day and Rs 1,500 crore of 182-day T-bills this week including Rs 3,000 crore of 91-day and Rs 1,000 crore of 182-day T-bills under MSS.

Corporate bonds saw five-year benchmark bonds yields move lower week-on-week.The five-year AAA bonds were quoting at 9.00% levels, lower by around by 15 bps week-on-week.

The five-year AAA spreads closed lower by 5 bps at around 120 bps levels. The corporate bond curve is flat with the one to ten-year bonds trading within a 20 bps range. The curve will remain flat given high short-end supply and good trading interest at the long ends.

Overnight index swaps (OIS) saw the swap curve move lower while inverting on improved interest rate outlook. One year OIS yields fell by 17 bps to close last week at 6.93% levels while the five-year OIS yields closed lower by 24 bps at 6.83% levels. The one-over-five spread closed at 10 bps from 3 bps seen in the week earlier to last.

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.