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ShareBond yields are likely to trend down in the near term on the back of a few interest rate factors turning positive. Ten-year benchmark bond yields may go down by 20-25 basis points (bps) from current levels of 7.3%.
The factors that have turned positive for interest rates are a fall in asset prices globally, the Reserve Bank of India (RBI) maintaining status quo on policy rates in the policy review and sustained positive cash balances of the government with the RBI.
Global asset prices are trending downwards on the back of fresh worries of economic recovery. Equities and commodities, including oil prices, have fallen 5-10% from highs and are showing further signs of weakness.Global bond yields have followed asset prices as money is moving into safer assets on the back of a question mark on economic recovery. The RBI maintained status quo on policy rates in its second quarter policy review last week despite sounding very hawkish on inflation.
The market now has a three-month trading window before the RBI starts hiking policy rates, and will look at global factors in taking trading views. The positive sentiment for interest rates globally will be reflected in domestic bond yields. The market will also be helped by the fact that the government will stick to its borrowing schedule, given the comfortable state of government finances and surplus balance maintained with the RBI.
The RBI has clearly spelt out its exit strategy for the ultra-loose accommodative policy.
The policy accommodation will be removed in stages, with the first stage implemented in the policy review last week. The RBI withdrew non-conventional easy policy measures by increasing the statutory liquidity ratio (SLR) to 25% from 24%, reducing export credit finance limit to 15% from 50% and withdrawing the special repo window for banks, mutual funds and non-banking finance companies.
The second stage, most likely to be implemented in the policy review in January 2010, is raising the reverse repo, repo and cash reserve ratio (CRR) rates. The RBI has shifted its policy stance from pro-growth to price stability with inflation target set at 6.5% for end-March 2010.
Inflation as measured by the wholesale price index (WPI) came in at 1.51% for the week ended October 17, 2009. It is likely to trend higher in the coming weeks on waning base effect.
Liquidity, as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) auction of the RBI remained high, with bids for reverse repo at around Rs 90,000 crore. Overnight rates were at 3% levels and are likely to remain at 3-3.25% levels given the high system liquidity.
Government bonds
Government bonds saw 10-year yields move down week-on-week as the central bank raised the SLR limit of banks and kept policy rates unchanged. The 10-year benchmark bond, the 6.9% 2019 bond, saw yields move down by 15 bps to close the week at 7.3% levels. The new five-year benchmark, the 7.32% 2014 note, saw yields move down by 14 bps to close at 7.12% levels. The 6.35% 2020 bond saw yields close down 11 bps at 7.75% levels, while the long bond -- the 8.24% 2027 bond -- saw yields close down 8 bps at 8.24% levels.The government is auctioning Rs 9,000 crore of bonds this week. The bonds to be auctioned are the 7.02% 2016 bond for Rs 3,000 crore, the 6.35% 2020 bond for Rs 4,000 crore and the 7.50% 2034 bond for Rs 2,000 crore.
Treasury bills, corporate bonds & overnight index swaps
Treasury bill (T-bill) yields were flat in the 91-day T-bill auction held last week with the cut-off coming in at 3.23% against a similar cut-off in the previous auction.The 182-day T-bill auction saw cut-off at 3.97% against a cut-off of 4.05% seen in the previous auction. The RBI is auctioning Rs 7,000 crore of 91-day T-bills and Rs 2,000 crores of 364 day T-bills this week.
Corporate bond yields were lower week-on-week on the back of the RBI holding policy rates. Five-year benchmark bonds traded at 8.50% levels while 10-year benchmark bonds traded at 8.82% levels, down 5 bps and 4 bps, respectively. Five-year spreads closed higher by 10 bps at 125 bps levels, while 10-year spreads closed up by 10 bps at 327 bps levels. Credit spreads may move higher as government bond yields fall while corporate bond yields remain sticky.
Overnight index swaps (OIS) saw the curve move down week-on-week on the back of the RBI maintaining status quo on policy rates. The five-year OIS yield closed lower by 15 bpsat 6.8% levels while the one year OIS yield closed lower by 15 bps at 4.8% levels.The one-over-five spread closed flat at 202 bps levels. OIS yields are likely trend down in the near term on the back of positive rate factors.
The writer is head, fixed income, IDFC Mutual Fund. Views are personal.
