Mumbai: Market deleveraging on the back of interest-rate negative factors coupled with muted investor appetite at lower yield levels is likely to push bond yields higher.
Ten-year benchmark bond yields have fallen by around 15 basis points to levels of 7.19% on the back of positive near term factors including a fall in global bond yields, lower oil prices and a short break in government bond supply.
The market will have to grapple with many interest-rate negative factors in the coming weeks, including volatility in global financial markets, higher trending inflation expectations and uncertain government finances. The market will also have to get rid of the existing floating stockbefore absorbing fresh supply. Investors, however, will show resistance in absorbing trader selling at lower levels of yields. This will push up bond yields in the near term.
Global financial markets have seen higher volatility in the last few days on the back of worries of debt default by entities in the Middle East. The repercussions of the default issue will be felt in money moving out of risky asset classes including emerging market equities, debt and currencies. India can feel the pinch if FIIs sell equity, debt and the currency.
A falling equity market will also put pressure on the government disinvestment programme as well as cast doubt on interest in 3G auctions. The government is expected to raise close to Rs 100,000 crore in disinvestment as well as 3G auctions. Inflation expectations have risen on the back of primary article price inflation coming in at over 11% year on year. Market will start looking at numbers well in excess of the 6.5% RBI target inflation for end-March, 2010.
The market, which was highly underleveraged a few weeks back, is now highly leveraged. It has absorbed a large percentage of Rs 20,000 crore of supply in the last two auctions, as well as selling from nationalised banks that were seen booking profits in the current rally. The market may not have holding capacity in the coming weeks to keep this leverage as well as take in fresh supply from auctions. The deleveraging will have to come at the cost of higher yields.
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 100,000 crore. Overnight rates were at 3% levels. Overnight rates are likely to remain at 3-3.25% levels given high system liquidity.
Government bonds
Government bonds saw ten-year yields close almost flat week on week. The ten-year benchmark bond -- the 6.90% 2019 paper -- saw yields close the week at 7.19% levels, up 1 basis point. The new five-year benchmark bond -- the 7.32% 2014 paper -- saw yields move up 4 basis points (bps) to close at 6.92% levels. The 6.35% 2020 bond saw yields close down 10 bps at 7.45% levels, while the long bond -- the 8.24% 2027 paper ---saw yields close down 2 bps at 8.09% levels.
The government is auctioning Rs 10,000 crore of bonds this week. The bonds to be auctioned are 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 crore.
Treasury bills, corporate bonds and overnight index swaps
Treasury bill (T-bill) yields were flat in the 91-day T-bill auction last week, with the cut-off on the 91-day T-bill auction held on November 25 coming in at 3.27% against a similar cut-off seen in the previous auction. The 182-day T-bill auction saw the cut-off at 3.74% against a cut-off of 3.82% seen in the previous auction. The RBI is auctioning Rs 4,500 crore of 91-day T-bills and Rs 1,000 crore of 364-day T-bills this week.
Corporate bond yields were lower week on week on the back of poor investor demand.
Five-year benchmark bonds traded at 8% levels, while ten-year benchmark bonds traded at 8.5% levels, down 10 bps and 5 bps, respectively. Five-year spreads closed lower by 10 bps at 98 bps levels, while ten-year spreads closed down 2 bps at 120 bps levels. Corporate bond yields are likely to stabilise at current levels as absolute levels of yields and low spreads may deter buyers.
Overnight index swaps (OIS) saw the curve move down week on week on the back of short position unwinding. The five-year OIS yield closed lower by 9 bps at 6.43% levels, while the one-year OIS yield closed lower by 5 bps at 4.53% levels. The one over five spread closed lower by 4 bps at 190 bps levels. OIS is likely to see incremental paying at lower levels on uncertain interest rate outlook.
Disclaimer: The author is head--fixed income, IDFC Mutual Fund. Views are personal.


