Comment

The market was stuck in a tight range last week, with the benchmark 10-year bond hardly moving more than 2 bps either way. The bond closed last week at 7.89% levels, higher by 1 bps week on week.

The market had built long positions anticipating good bidding interest across the participation segment on the back of interest rate positive global cues.

However, buying failed to materialise at below 7.88% levels while traders were reluctant to sell at higher levels of yields.

This kept the market in a tight range. The curve, however, saw further flattening with the one over five swap curve flattening completely from 2 bps spread seen in the week earlier to last. The market is unsure of liquidity conditions and prefers to bid the long end while selling short end of the curve.

System liquidity as measured by bids in the Liquidity Adjustment Facility of the RBI swung from negative to positive last week, leaving the market wary on liquidity conditions.

The market is going into this week with fresh auction stock. The RBI ( Reserve Bank of India) had held a government bond auction for Rs 7,000 crore on November 23 under the government borrowing programme.

The auction was well bid with cutoffs coming in positive. The market will try and rally the auction stock, and if market is still reluctant to bid at lower yields, there could be some position paring, leading to yields moving higher.

The market is torn between domestic and global cues. Globally US treasury yields were factoring a rate cut by the US Federal Reserve. Other Central Banks are putting rate hikes on hold or are looking to cut to spur their economy.

On the domestic front, broad money supply growth at 23.8% as of November 9, 2007, is a cause for concern. RBI had front run higher money supply growth by hiking the cash reserve ratio (CRR) last month, but more data must show their policy moves paying off or there could be more liquidity-tightening measures.

The system liquidity swung from negative to positive last week. Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI ended the week positive with Rs 8000 bids for reverse repo at 6%.

The week had seen bids for repo at 7.75% crossing Rs 30,000 crore. Overnight rates came off on positive liquidity and closed at around 6% levels.

Government bonds

Government bond yields closed almost flat week on week. The yield on the benchmark 10-year bond 7.99% 2017 bond closed higher by 1bps to close at 7.89% levels.

Five-year benchmark bond yields closed flat with the yield on the 7.40% 2012 bond closing at 7.83% levels. Yields on the long bond the 8.33% 2036 bond closed higher by 1bps at 8.36% levels.

The RBI auctioned Rs 7,000 crore of government bonds last week. The bonds auctioned were the 7.99% 2017 bonds for Rs 3,000 crore and the 8.35% 2022 bonds for Rs 4,000 crore.

The auction saw good bidding interest and the cutoffs came is positive. The cut off on the 7.99% 2017 bond was at 7.90% levels and was at market expectations while the longer bond saw the cut off at 2bps above market expectations at 8.20% levels. The market will look to rally the auction stocks failing which position paring will see yields moving higher.

Treasury bills (T-bills) yields were flat week on week. The cut off on the 91-day T-bill auction held on the November 21 came inat 7.52% against a similar cut off seen in the previous auction. The 364 day T-bill auction saw the cut off coming in at 7.75% against 7.76% 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 1,500 crore of 182-day T-bills this week, including Rs 1,500 crore of 91-day and Rs 1,000 crore of 182-day T-bills under MSS. Liquidity conditions are likely to determine auction bids.

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

The five-year AAA bonds were quoting at 9.35%-9.40% levels while one year levels were around 9%. The five-year AAA spreads closed flat at around 142bps levels. Credit spreads are likely to take direction from liquidity and supply.

Overnight index swaps (OIS) saw the swap curve flatten on uncertain liquidity conditions. One-year OIS yield rose by1bps to close last week at 7.25% levels while the five year OIS yield closed lower by 1bps at 7.25% levels. The one over five spread closed flat from a spread of 2bps levels. The curve will look to invert if liquidity remains tight.

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.