Worry lines forming in the market

Oil prices, liquidity, government borrowing and an equity rally are all preying on the bond market’s mind, leading to a consolidation of bond yields at 8.20% levels on the ten-year benchmark bond.

Inflation printing at below 7% levels and the Reserve Bank of India (RBI) infusing liquidity through OMO (open market operation) purchase auctions kept the market sentiments stable, but given the market’s worries a fresh rally in the ten-year benchmark bond from 8.20% levels is not on the cards if the negatives act up.

Oil prices touched $120/barrel (Brent crude) last week on worries of geo-political tension with Iran and on improved commodity markets sentiments on the back of a strong global equity rally.

Equities have rallied between 10% and 20% in the calendar year to date across global equity indices, helped by liquidity infusion from central banks.

The US Federal Reserve, European Central Bank (ECB), Bank of Japan and Bank of England have all pledged to infuse more liquidity into the system to spur economic growth.

The ECB is slated to lend around euro one trillion later this month to European banks at 1% for three years. The huge liquidity infused by central banks is helping equity and commodity markets.

Oil prices have risen over 10% during the calendar year on the back of the liquidity-led rally in equities and the Iran nuclear programme stand-off.

Tensions with Iran have led to rumours of Iran cutting oil supplies to countries that are against its nuclear programme.

Iran is also threatening to close shipping routes that could lead to military tensions. Oil prices staying high will raise inflation expectations in India as also lead to the government subsidy bill rising.

The government borrowing for the fiscal 2013 is likely to be around Rs550,000 crore, as per a ministry official.

The borrowing will be higher by around Rs36,000 crore over the fiscal 2011-12 borrowing, and markets will work out the demand dynamics as the borrowing commences in April 2012.

If demand does not stack up, then markets will start worrying about absorbing next year’s supply.

Liquidity tightened by Rs56,000 crore last week with the system borrowing Rs167,000 crore from RBI on a daily average basis.

The rising liquidity pressure led to the RBI buying government bonds in OMOs. RBI bought close to Rs10,000 crore of bonds last week through OMOs.

Tight liquidity conditions are hurting market sentiments, given that a CRR (cash reserve ratio) cut of 50 basis points in January, which released Rs32,000 crore into the system, did not help ease liquidity pains.

Inflation as measured by the WPI (wholesale price index) came in at 6.55% for January 2012 as against a level of 7.47% seen in the previous month.

Manufacturing inflation declined to an 11-month low of 6.49% and rose by just 0.1% on a month-on-month basis.

Inflation dynamics are positive, given that the overall inflation is trending at over two-year lows.

The market will expect RBI to cut rates in March 2012, given tight liquidity, falling inflation numbers and the RBI broad consensus on rate cuts.

Tight liquidity conditions drove up rates on one year corporate papers. Yields on bank CDs (certificate of deposits) rose by 15 bps week on week to close the last week at 10.05% levels.

Short-term yields will remain pressured through March-end, given fiscal-end liquidity pressures.

The interest-rate swap curve fell on the back of inflation coming off. One- and five-year OIS (overnight index swaps) yields fell by 4 bps and 5 bps week on week, respectively. OIS yields are likely to trend with caution, given the market’s worries on oil prices, liquidity and government borrowing.

Government bond auctions
The government auctioned Rs12,000 crore of bonds last week. The bonds auctioned were the 8.24% 2018 for Rs3,000 crore, the 8.79% 2021 bond for Rs6,000 crore, and the 8.83% 2041 bond for Rs3,000 crore.

The cut-offs came in at 8.31%, 8.20% and 8.60%, respectively.

The government will auction Rs12,000 crore of bonds this week.

The RBI bought Rs9,858 crore of bonds last week in its bond purchase auction. The bonds purchased were the 8.07% 2017 bond for Rs1,525 crore at 8.24%, the 9.15% 2024 bond for Rs3,951 crore at 8.28%, the 8.28% 2027 bond for Rs2,897 crore at 8.52% and the 8.97% 2030 bond for Rs1,483 crore at 8.55%.

Arjun Parthasarathy is editor of
www.investorsareidiots.com, a
website for investors