Comment

Global weakness in equities and commodities also a factor to watch

The market spooked by liquidity and inflation fears, saw yields move higher week-on-week.

The movement was noticeable in the swap curve with the one-year swap yields moving higher by 16 bps and five-year swap yields moving higher by 10 bps week-on-week.

The curve inverted further with the one-over-five spread closing at negative 14 bps from negative 9 bps seen in the week earlier to last. Government bonds saw benchmark ten-year yields close higher by 4 bps at 7.90% levels.

Corporate bonds saw yields move higher by 10-20 bps across the board with the short end of the curve seeing pressure on increasing supply amidst tight liquidity conditions.

The coming week is expected to see further pressure on yields as liquidity tightens and inflation fears gain ground. The global weakness in equities and commodities is also a factor to watch in determining sentiments in interest rates and credit spreads.

Liquidity as measured by bids for reverse repo/ repo in the LAF (Liquidity Adjustment Facility) of the RBI (Reserve Bank of India) saw bids for repo at 7.75% as the market was forced to access the LAF window for funds.

Liquidity is expected to tighten further as advance tax outflows hit the system this week, while ongoing equity issuances are seeing high demand for funds.

Inflation as measured by the WPI (Wholesale Price Index) came in higher than expected at 3.75% for week ended December 1, 2007.

Market expected inflation to come in at 3.49% levels. Inflation numbers for the US were also higher than expected as the core CPI (Consumer Price Index) came in at 0.3% for month of November 2007 against expectations of 0.2%.

US treasuries saw yields move up 23 bps from lows during last week on the back of a lower than expected rate cut by the US Federal Reserve (Fed), higher inflation and better than expected retail sales numbers.

The move by the Fed to infuse as much as $60 billion in the system with support from the ECB (European Central Bank) and the Swiss National Bank caused nervousness in markets on the liquidity situation.

Global liquidity is still tight as credit fears are increasing on the scale of write offs due to subprime crisis.Financial markets are now faced with the worst possible situation of weakening economies, tight liquidity and higher inflation.

Government bonds
Government bonds saw the long bond outperform the rest of the curve. The yield on the benchmark ten-year bond 7.99% 2017 bond was higher by 4 bps to close at 7.90% levels.

Five-year benchmark bond yields was unchanged 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 1 bps at 8.25% levels.

The RBI auctioned Rs 7,000 crore of government bonds under the government borrowing programme last week.

The bonds auctioned on December 14 were the 7.99% 2017 bond for Rs 5,000 crore and the 8.33% 2036 bond for Rs 2,000 crore.

The cuts-offs were mixed, with the cut off on the 7.99% 2017 bond coming in lower than expectation while the cut off on the 8.33% 2036 bond coming in better than expectations.

The cut-off on the 7.99% 2017 bond was at 7.92% while the cut-off on the 8.33% 2036 bond was at 8.26%. Bond yields are expected to be pressured on liquidity and inflation fears.

Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were lower last week on reduced supply.The cut-off on the 91-day T-bill auction held on December 12 came in at 7.44% against a cut-off of 7.52% seen in the previous auction.

The 182-day T-bill auction saw the cut-off coming in at 7.60% against 7.71% seen in the previous auction. The RBI is auctioning Rs 500 crore of 91-day and Rs 1,000 crore of 364-day T-bills this week.

T-bill yields will trend higher on tight liquidity conditions.

Corporate bonds saw five-year benchmark bonds yields move higher week-on-week, while the short end rates were pressured on tight liquidity and increased supply.

The five-year AAA bonds were quoting at 9.30% levels higher by around 7-10 bps week-on-week while one-year levels were around 9.30% to 9.40% levels, higher by 20 bps.

The five-year AAA spreads closed higher by 10 bps at around 133 bps levels. Corporate bonds are likely to see spreads pressured on the back of tight liquidity and supply pressures.

Overnight index swaps (OIS) saw the swap curve moving higher while inverting further on liquidity fears. One year OIS yield rose by 16 bps to close last week at 7.33% levels while the five-year OIS yield closed higher by 10 bps at 7.18% levels. The one-over-five spread closed at negative 14 bps from negative 9 bps seen in the week earlier to last.

Swaps yields will be pressured on liquidity and inflation outlook.

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.