Comment

Demand from provident funds to be the key trigger

The yield on the benchmark long bond 8.33% 2036 moved down 10 bps week on week, outperforming the rest of the curve.

The bond saw buying interest in anticipation of demand from provident funds as the SDS (special deposit scheme) interest payment will flow into funds in the first week of January 2008.

Five-year corporate bonds also saw demand at 9.20% levels on anticipation of SDS interest.

The 10-year benchmark yields fell by 4 bps to close the week at 7.86% levels while the 5-year bonds underperformed on liquidity pressures. The swap curve moved down, while remaining inverted.

The market sentiment was boosted by interest rate cuts by Bank of England (BOE) which cut benchmark rates by 25 bps, citing growth pressures.

Bank of Canada also cut rates on growth worries. However, the Central Banks were cautious on the inflation front, and warned that inflation will trend over the targeted levels in the short term while it is likely to fall in the longer term as the economy slows.

The US Federal Reserve (Fed) will meet on the December 12 to decide on policy moves. The Fed is likely to cut benchmark rates by 25 bps with an outside chance of a 50 bps cut on worries over growth of the US economy.

The probability of a 50 bps cut dimmed on the back of a better than expected payroll number, which came in at 94000 jobs being added against expectations of 80,000 jobs. US benchmark yields moved by over 10 bps on the back of the number.

On the domestic front, inflation as measured by the WPI (wholesale price index)came in better than expected at 3.01% for week endedNovember 24, 2007.

Market expected inflation to come in at 3.20% levels. Credit growth for week ended November 23, 2007 was at 23.3% while broad money growth was at 22.8%. The former is below RBI’s target of 23% to 24% while the latter is higher than target of around 18%.

Liquidity conditions eased towards end of the week as pressure on banks product came off. Overnight rates came off by 100 bps from 7.5% levels to 6.5% levels on easing liquidity pressure.

The RBI has announced a government bond auction for Rs 7,000 crore to be held this week. The auction coupled with advance tax outflow pressures is likely to keep liquidity tight.

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 one day mid week saw bids for reverse repo.

The RBI was rumoured to have bought bonds last week to shore up their holdings of securities and this could have added liquidity into the system.

Government bonds
Government bonds saw long end yields move down last week. The yield on the benchmark 10-year bond 7.99% 2017 bond was lower by 4bps to close at 7.86% levels.

Five year benchmark bond yields was higher by 2bps with the yield on the 7.40% 2012 bond closing at 7.82% levels. Yields on the long bond the 8.33% 2036 bond closed lower by 10bps at 8.26% levels.

The RBI is auctioning Rs 7,000 crore of government bonds under the government borrowing programme this week. The bonds to be auctioned on December 14 are the 7.99% 2017 bond for Rs 5,000 crore and the 8.33% 2036 bond for Rs 2,000 crore.

The auction will be well-bid and cutoffs will be positive given positive interest rate sentiments.

Treasury bills,corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were flat last week. The cut off on the 91 day T-bill auction held on December 4 came inat 7.52% against a similar cutoff seen in the previous auction.

The 364-day T-bill auction saw the cutoff coming in at 7.71% against 7.75% seen in the previous auction. The RBI accepted Rs 1,500 crore of bids in the 91-day T-bill auction. The RBI is auctioning Rs 500 crore of 91-day and Rs 500 crore of 182-day
T-bills this week.

Corporate bonds saw five year benchmark bonds yields move down week on week, while the short-end rates saw pressure on tight liquidity.

The five-year AAA bonds were quoting at 9.20% levels down by around 7 to 10 bps week on week while one year levels were around9% to 9.3% levels.

The five-year AAA spreads closed down 12 bps at around 123 bps levels. Short-end corporate bonds are likely to see yields pressured on the back of tight liquidity and supply pressures while long bonds will see good bids on the back of demand from provident funds.

Overnight index swaps (OIS) saw the swap curve moving down while remaining inverted on interest rate and liquidity factors. One-year OIS yield fell by4 bps to close last week at 7.17% levels while the five year OIS yield closed lower by 3 bps at 7.08% levels. The one over five spread closed at 9 bps almost unchanged week on week.
Swaps will move on interest rate outlook which is positive at present.

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.