Comment

Bond yields are set for a good rally on the back of reduced concerns over the size of government borrowing and on the back of a benign macro environment for interest rates.

The government reduced the size of this week’s auction from Rs 15,000 crore seen over the previous seven auctions to Rs 12,000 crore. The government in the Union Budget presented on July 6 has projected a fiscal deficit of 6.8% of gross domestic product (GDP).

The fiscal deficit translates into Rs 4 lakh crore of net borrowing or Rs 4.5 lakh crore of gross borrowing. The gross borrowing is Rs 90,000 crore more than the number of Rs 3.6 lakh crore projected in the vote on account in February 2009. The higher borrowing of Rs 90,000 crore is not as daunting as it looks on the back of a couple of factors.

The first is that it includes Rs 28,000 crore of market stabilisation scheme (MSS) bonds desequestered this fiscal. The second is that the government has till now borrowed an additional Rs 25,000 crore, leaving an additional Rs 37,000 crore to be borrowed, which can be spaced out evenly over the next few months. A new borrowing calendar is likely to be announced at the end of this week, which may be easier for the market to digest.

The global macro environment is positive for interest rates. The concern over global economic growth is coming back with weak unemployment, consumer confidence and export data. The weaker-than-expected growth data has prompted a sell-off in oil and other commodity prices. Oil prices have come off by over 10% from highs. Global bond yields have rallied by 50-70 basis points from highs seen in June 2009.

Inflationary fears of high system liquidity generated by central bank actions of quantative easing have reduced. Bond yields will be well supported at higher levels unless there is concrete evidence of the world going back to normal level of growth and employment.

Inflation as measured by the wholesale price index (WPI) came in below market expectations of negative 1.47% at negative 1.55% for the week ended June 27. Index of industrial production (IIP) growth for May 2009 came in better than expectations of 1.2% at 2.7%. Exports growth for June 2009 is pegged at negative 29%, the eighth consecutive month of negative growth.

Liquidity as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) auction of the Reserve Bank remained high with bids for reverse repo crossing Rs 1.5 lakh crore. Overnight rates were at 3% levels. Liquidity will continue to be high in the system keeping overnight rates low.

Government bonds
The yield on the most-traded bond — the five-year benchmark 6.07% 2014 note, closed up 23bps at 6.45% levels week-on-week on the back of budget disappointment. The recently auctioned 7.94% 2021 bond saw yields move up34bps to close at 7.34% levels. The long end of the curve saw yields move up 23bps with the yield on the 7.50% 2034 bond closing at 7.98% levels from 7.75% levels.

The government auctioned Rs 15,000 crore of bonds last week. The new 10-year bond auction for Rs 6,000 crore saw the cut-off coming in at 6.90% as per market expectations.

The 6.49% bond auctioned for Rs 5,000 crore saw cut-off coming in at 6.55%, 5bps higher than market expectations, while the 7.35% 2024 and 7.50% 2034 bond auctions of Rs 2,000 crore each saw the cut-offs coming in as per market expectations of 7.45% and 7.98% respectively.

The RBI bought back Rs 1,661 crore of bonds last week against a purchase target of Rs 7,500 crore. The interest in the open market operation (OPO) purchase auction was muted as banks were reluctant bidders at higher levels of yields.

The government is auctioning Rs 12,000 crore of bonds this week. The bonds to be auctioned are the 6.07% 2014 bond for Rs 6,000 crore, the 7.94% 2021 bond for Rs 4,000 crore and the 7.40% 2035 bond for Rs 2,000 crore.

Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were higher in the 91-day T-bill auction held last week with the cut off on the 91-day T-bill auction held on July 8 coming in at 3.23% against a cut-off of 3.11% in the previous auction. The 182-day T-bill auction saw the cut-off coming in at 3.43% against a cut-off of 3.53% in the previous auction. The RBI is auctioning Rs 8,000 crore of 91-day T-bills and Rs 1,000 crore of 364-day T-bills this week.

Corporate bond yields were higher week-on-week on the back of a rise in government bond yields. Five-year benchmark bonds traded at 8.05% levels, up 20bps week-on-week while 10-year benchmark bonds traded at 8.63% levels, up 14bps week-on-week. Five-year spreads closed flat at 150bps levels, while 10-year spreads closed higher by 5bps 163bps levels. Credit spreads are likely to remain flat as supply comes in.

Overnight index swaps (OIS) saw the curve trend down week-on-week on the back of fall in global bond yields. The five-year OIS yield closed down 8bps at 6.07% levels while the one year OIS yield closed down 9bps at 4.03% levels. The OIS curve is likely to trend down in the coming weeks on the back of improved interest rate sentiments.

Disclaimer: The author is head-fixed income, IDFC Mutual Fund.
Views are personal