Comment

Overnight ratesseen staying over the repo rate

The market saw five-year OIS (overnight index swaps) move down 14bps week on week, and the government bonds were stuck in a tight range.

The 10-year benchmark bond yield was up by a bps while the 5-year benchmark bond yield came off by 2bps week on week.

The 5-year OIS and 5-year government bond spread widened to 69bps from 58bps seen a week back. The swap yield curve inverted with the one over five spread moving up to 10bps from flat levels week on week.

The sharp fall in the 5-year swap yields was partly caused by unwinding of spread positions. Players had put on OIS-government bond spread in the hope that the spread would narrow.

However, with government bonds staying flat and OIStrending down on global cues, the spread positions went out of the money and were forced to unwind.

The fact that the 5-year swap is trading at 58bps lower than the government bond suggest that the market is expecting yields to fall down the line.

The increased expectations of a rate cut by the US Federal Reserve (Fed)has brought down 10-year US treasury yields below 4% levels.

The Fed is expected to cut rates by 25-50 bps in their December policy meet. The Fed move will also force major central banks to hold or cut rates next year.

The RBI (Reserve Bank of India) has tightened liquidity through CRR (cash reserve ratio) hikes, issue of MSS (market stabilisation bonds) and curbing liquidity flows through policy measure of ECB (external commercial borrowings).

The RBI has, however, left benchmark interest rates steady at 6% (reverse repo rate) though they have raised the repo rate to 7.75%, widening the reverse repo to repo spread by 75bps.

The market is seeing tight liquidity conditions at the moment, which is forcing players to play the swap curve to execute interest rate views rather than buying cash bonds.

The system liquidity was negative last week. Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI saw bids for repo at 7.75% while there were no bids for reverse repo.

December will also see advance tax outflows hitting the system.

Lack of government spending, slowing down of foreign portfolio flows, large amount of domestic equity issuances and demand for credit will keep liquidity tight.

The RBI buying of bonds from the secondary market, to add to their outstanding securities, could lead to liquidity relief.

However near-term outlook for liquidity is negative and overnight rates will trade over the repo levels of 7.75%.

Government bonds

Government bond yields moved in a narrow range. The yield on the benchmark 10-year bond 7.99% 2017 bond closed higher by 1bps to close at 7.90% levels. 5-year benchmark bond yields closed down 3bps with the yield on the 7.40% 2012 bond closing at 7.80% levels.

Yields on the long bond 8.33% 2036 bond closed lower by 2bps at 8.34% levels.

Treasury bills,corporate bonds and overnight index swaps

Treasury bills (T-bills) yields were pressured last week. The cutoff on the 91-day T-bill auction held on of November 28 came inat 7.52% against a similar cut off seen in the previous auction. The 182-day T-bill auction saw the cut off coming in at 7.71% against 7.60% seen in the previous auction.

The RBI rejected bids for MSS (market stabilisation scheme) component of the auction, given liquidity conditions.

The RBI is auctioning Rs 2,000 crore of 91-day and Rs 2,000 crore of 364 day T-bills this week including Rs 1,500 crore of 91-day and Rs 1,000 crore of -82 day T-bills under MSS. Auction is likely to see bids at higher yields given negative outlook for liquidity.

Corporate bonds saw 5-year benchmark bonds yields almost flat week on week, while the short end rates saw pressure on tight liquidity.

The 5-year AAA bonds were quoting at 9.30% levels while one year levels were around 9.10%. The 5-year AAA spreads closed flat at around 135ps levels. Short-end corporate bonds are likely to see yields pressured on the back of tight liquidity and supply pressures.

Overnight index swaps (OIS) saw the swap curve invert on interest rate and liquidity factors. One-year OIS yield fell by4bps to close last week at 7.21% levels while the five-year OIS yield closed lower by 14bps at 7.11% levels.

The one over five spread closed at 10bps from flat levels seen in the week earlier to last. The curve will invert further as liquidity outlook is negative.

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.