Comment

The bond markets gave up four weeks of gains in just a week on the back of inflation worries and sooner than expected RBI action. Ten-year benchmark bond yields surged to one month highs of 7.47%, week-on-week, as traders offloaded long positions built into the rally.

Primary article inflation, which is released weekly, came in at 12.53% for the week ended November 21. The high level of primary article inflation is likely to push up the monthly inflation as measured by the wholesale price index (WPI) for November, to levels of over
3.5%.

If the current inflation trend continues, the March-end target of 6.5% expected by the Reserve Bank of India (RBI) is most likely to be breached by a wide margin. GDP growth of 7.9% for the April-September 2009 period was better than market expectations.

High GDP growth numbers coupled with higher than expected inflation numbers will prompt the RBI to revise both GDP and inflation projections upwards. The market is now expecting the RBI to raise policy rates sooner than expected.

It will now have to contend with a better than expected US jobs data that caused high volatility in currency and asset markets. Data showed US employers reducing workforce in November by only 11,000 against consensus expectations of 1,20,000.

The previous month’s figures were revised lower indicating fewer jobs were reduced. The better than expected jobs data prompted a reversal in trends in currency and commodity markets. The dollar, which was weakening steadily against majors, jumped higher by 2% while gold and other commodity prices fell by around 2% on the back of a stronger dollar.

US bond yields climbed by 10-14 basis points (bps) across the curve on the back of the data. The markets will now expect the US Federal Reserve to raise rates sooner than expected, prompting a stronger dollar and a subsequent reversal in carry trades.

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 1,00,000 crore. Overnight rates were at 3% levels. Overnight rates are likely to remain at 3% to 3.25% levels given high system liquidity.

Government bonds
Government bonds saw bond yields across the curve close higher, week-on-week. The ten-year benchmark bond the 6.9% 2019 bond saw yields close the week at 7.47% levels up by 28 bps. The new five-year benchmark bond, the 7.32% 2014 bond, saw yields move up by 14 bps to close at 7.06% levels. The 6.35% 2020 bond saw yields close up 20 bps at 7.65% levels, while the long bond the 8.24% 2027 bond saw yields close up 14 bps at 8.23% levels.

The government auctioned Rs 10,000 crore of bonds last week. The bondsauctioned were the 7.06% 2016 bond for Rs 3,000 crore, the 6.90% 2019 bond for Rs 4,000 crore and the 8.28% 2032 bond for Rs 3,000 crores. The cut-offs came in at 7.31%, 7.39% and 8.31% respectively.

The government is auctioning Rs 10,000 crore of bonds this week. The bonds to beauctioned are the 7.32% 2014 bond for Rs 3,000 crore, the 6.35% 2020 bond for Rs 4,000 crore and the 8.24% 2027 bond for Rs 3,000 crore.

Treasury bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) 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 December 2, 2009 coming in at 3.32% against a cut-off of 3.27% seen in the previous auction.The 364-day T-bill auction saw the cut-off coming in at 4.5% against a cut-off of 4.45% seen in the previous auction. The RBI is auctioning Rs 5,000 crore of 91-day T-bills and Rs 1,000 crore of 182-day T-bills this week.

Corporate bond yields were higher week-on-week as bidders vanished at lower levels of yields. Five-year benchmark bonds traded at 8.25% levels while ten-year benchmark bonds traded at 8.63% levels up 25 bps and 13 bps, respectively. Five-year spreads closed higher by 12 bps at 110 bps levels while ten-year spreads closed down 10 bps at 110 bps levels. Corporate bond yields are likely to remain offered on the back of worries of RBI withdrawing liquidity from the system.

Overnight index swaps (OIS) saw the curve move up week-on-week on the back of fresh paying interest. The five-year OIS yield closed up by 35 bps at 6.78% levels, while the one year OIS yield closed up by 39 bps at 4.92% levels. The one over five spread closed lower by 4 bps at 186 bps levels. OIS are likely to see the curve move up on the back of expectations of rate hikes by the RBI.

Disclaimer: The writer is head, fixed income at IDFC Mutual Fund. Views are personal