Comment

Longs have been built up presaging a 25 bps cut by RBI

Till the US Federal Reserve made its unscheduled 75bps rate cut on Tuesday last, the local bond market was not factoring in a rate cut by the Reserve Bank of India (RBI), though there were expectations of a benign monetary policy on the back of a US recession threatening to drag global growth.

Bond yields had come off by almost 40bps over a month as markets started factoring in slower growth scenarios.

The Fed cut, however, has changed expectations completely.
The larger-than-expected slicing, which came suddenly, has local players presaging a rate cut by the RBI to:
a) stave off threats of a US recession on the Indian economy; and,
b) reduce the widening interest rate differential of over 500bps at the short end of the curve.

Participants are going long into the policy review on Tuesday, January 29, expecting the RBI to cut benchmark rates by 25bps.

The market is also helped by the high expectations of the Fed further cutting benchmark rates by 50bps in its scheduled policy meet on Wednesday, January 30.

The rate-cut expectations (by both the RBI and the Fed) are high and if any of them fail to deliver, yields can move up sharply as players unwind longs built on bullish sentiments.

Last week was eventful with two major events and significant expectations built into those events.

There market had some-last minute jitters and gave up some gains seen post the Fed action. Ten-year yields, which had touched lows of 7.35%, closed the week at 7.42% levels on some fag-end unwinding.

The RBI has announced Rs 5,500 crore of auctions under market stabilisation scheme (MSS) including dated bonds for Rs 3,000 crore.

Inflation as measured by the Wholesale Price Indexcame in lower than expected at 3.83% for week endedJanuary 12, 2008. The consensus call was around 3.87%.

Liquidity as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) of the RBI saw bids for reverse repo at 6% averaging Rs 8,890 crore last week against Rs 24,000 crore in the week earlier to last.

The auction also saw bids for repo as a few banks were caught short of funds. Overnight rates hovered around 7% on uncertain liquidity.

Government bonds
Government bonds saw yields fall across the curve. Ten-year yields (7.99% 2017) were lower by 13bps to close at 7.42% levels. Five-year was down 15bps with the yield on the 7.27% 2013 bond closing at 7.37% levels. Yields on the long bond the 8.33% 2036 bond closed lower by 13bps at 7.88% levels.The 10-over-30 spread closed unchanged at 29bps levels.

The government bond auctions of6.57% 2011 bond for Rs 3,000 crore and 12.25% 2010 for Rs 3,000 crore under MSS saw the cut-off coming in at 7.36% and 7.41%, respectively.

The auction saw good bids by banks who were shoring up their statutory liquidity ratio. The RBI is auctioning Rs 3,000 crore of dated bonds under MSS this week. The bond to be auctioned is the 11.30% 2010. The cut-offs are likely to be determined by the policy statements.

Treasury bills, corporate bonds and overnight index swaps
Treasury bill yields were higher last week on increased size of issuances at the short end of the curve. The cut-off on the 91-day bill at the auction held on January23 came in at 7.19% against a cut-off of 7.10% seen in the previous auction. The 182-day bill auction saw the cut-off at 7.25% against 7.23% in the previous auction. RBI accepted bids for Rs 2,589 crore and Rs 2,105 crore against auction sizes of Rs 3,500 crore and Rs 2,500 crore, respectively.

The RBI is auctioning Rs 2,000 crore of 91-day and Rs 2,000 crore of 364-day bills this week including Rs 1,500 crore of 91-day and Rs 1,000 crore of 364-day bills under MSS.

Corporate bonds saw benchmark bonds yields becoming sticky at 8.90% to 9% levels on fears of increased supply and sharp rise in credit spreads globally.

The five-year AAA bond spreads were around 144bps levels, while ten-year spreads were 139bps levels. Bonds at end saw yields pressured on uncertain liquidity.

Overnight Index Swaps (OIS) saw the swap curve move lower on the back of Fed rate cut.

One-year OIS yields fell by 14bps to close last week at 6.61% levels, while the five-year OIS yields closed flat 14bps at 6.53% levels. The one-over-five spread closed flat at negative 8bps. OIS market will take directions from RBI policy statements.

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.