Comment

Market to bid cautiously, thanks to the uncertain rate outlook

MUMBAI: The bond markets had expected the Reserve Bank of India (RBI) to cut benchmark interest rates at its policy review on January 29, 2008. The markets had factored in a US Federal Reserve (Fed) rate cut of 50bps ar its meet on January 30 following an unexpected cut by 75bps in the week earlier to last. The RBI did not meet market expectations, citing inflationary pressures in the economy while the Fed Reserve delivered the expected cut.

The bond markets reacted negatively to RBI status quo on policy rates with yields jumping up by almost 10bps. The benchmark 10-year 7.99% 2017 bond saw yields move up by 8bps from lows on the policy day. The market had built long positions on the hopes of an RBI rate cut as well as a Fed rate cut. The longs were cut after RBI held rates. The day following RBI policy review saw the Fed cutting rates by 50bps. The Fed cut, coupled with expectations of more cuts ahead, helped the market recover from lows and closed the week with yields 4bps better from highs.

The market will go into the week on the back of job losses in the US for the month of January. The threats of recession are becoming higher in the US and this is threatening to drag down world economy. Inflationary pressures persist globally with oil and food prices at elevated levels and the RBI is concerned on the inflation front but it may not follow the Fed in cutting rates. The RBI is likely to react only when domestic growth is looking to slow on the back of a global recession. This week will see the market facing Rs13,000 crore of dated bond auctions, including Rs4,000 crore under MSS (market stabilisation scheme). The market is likely to be cautious on the auction given that the rate cut expectations are dampened and yields are still down 30bps calendar year to date.

Inflation as measured by the WPI (wholesale price index)came in higher than expected at 3.93% for week endedJanuary 19, 2008. Market expected inflation to come in at 3.83% levels. Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI saw bids for reverse repo at 6% averaging Rs18,685 crore last week.. .The auction also saw bids for repo on the last two days of the week as there were liquidity mismatches in the system. Overnight rates were over 7% on uncertain liquidity.

Government bonds
Government bonds saw yields rise across the curve. The yield on the benchmark 10-year bond 7.99% 2017 bond was higher by 8bps to close at 7.50% levels. Five-year benchmark bond yields was higher by 9bps with the yield on the 7.27% 2013 bond closing at 7.46% levels. Yields on the long bond 8.33% 2036 bond closed higher by 12bps at 7.82% levels.The government bond auctions of 11.30% 2010 bond for Rs3,000 crore under MSS saw the cutoff coming in at 7.57% against the previous week cut off of 7.41% The RBI is auctioning Rs4,000 crore of 12.25% 2010 bonds under MSS this week. The cutoff may come higher given uncertain rate outlook.

The RBI is auctioning Rs9,000 crore of bonds under the government borrowing programme this week. The auction is as per the schedule given in the auction calendar for the second half of fiscal 2007-08. The bonds to be auctioned are the 8.20% 2022 bond for Rs5,000 crore and the 8.33% 2036 bond for Rs4,000 crore. The market is likely to bid cautiously given the uncertain rate outlook.

Treasury bonds,corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were higher last week on the back of RBI maintaining status quo on policy rates. The cut off on the 91-day T-bill auction held on January 30 came inat 7.27% against a cutoff of 7.19% seen in the previous auction. The 364 day T-bill auction saw the cut off coming in at 7.49% against a cut off of 7.39% seen in the previous auction. The RBI is auctioning Rs 2000 crores of 91-day and Rs1,500 crore of 182-day T-bills this week, including Rs1,500 crore of 91-day and Rs1,000 crore of 182-day T-bills under MSS. Corporate bonds saw benchmark bonds yields moving higher by 10bps week on week as RBI maintained status quo on rates. The 5-year AAA bond spreads were around 140bps levels. Spreads are likely to remain pressured on uncertain rate outlook.

Overnight Index Swaps (OIS) saw the swap curve move higher on the back of RBI maintaining status quo on rates. One year OIS yields moved higher by 10bps to close last week at 6.71% levels while the five year OIS yields closed higher by 12bps at 6.65% levels. The one over five spread came off by 2bps from negative 8bps to negative 6bps. OIS market will take directions from auction cutoffs.

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.