The markets last week saw a consecutive seven-week trend of rising yields being broken with the benchmark 10-year yields falling sharply by as much as 10bps.
The bond markets last week saw a consecutive seven-week trend of rising yields being broken with the benchmark 10-year yields falling sharply by as much as 10bps. The reasons for the rally in bond prices were an indication by the US Federal Reserve chairman Ben Bernanke that US rate hikes could be put on hold in their next policy meeting, statements by the finance minister that inflation would be contained and interest rates would be stable, and hopes that if there is a rate hike by the Reserve Bank of India (RBI) in the review of the monetary policy on July 25, it would be the last of the rate hikes for some time to come.
The market ignored falling stock markets, depreciating currency and rising oil prices due to tensions in the Middle East and concentrated on the fall in US treasury yields and comforting statements by the finance minister. The fact that the government had not announced a scheduled bond auction till the end of trading hours on the last day of the week also led to hopes of cancellation or postponement of the auction.
However, the auction announcement came in after trading hours on Friday, with the government announcing a sale of Rs 4000 crore of 7.55% 2010 bond on July 27. This auction date was changed from the scheduled calendar dates between July 16 and 25, the size was reduced from Rs 5000 crore to Rs 4000 crore and the maturity was reduced from 15-19 years to a 4-year maturity.
The market widely expects the RBI to raise interest rates by 25 basis points, as indicated by a survey conducted by Reuters. The fact that the government has announced an auction after the policy increases the probability of a rate hike. The market will, however, look for indications of future policy actions from RBI. If the RBI is seeing increased threat on inflation and financial stability, and sound hawkish, there would be a sell-off in bonds. On the other hand, if the RBI is dovish stating that inflation is controllable and RBI is in control of the financial situation, there could be a widespread rally in bonds. The market is keeping its fingers crossed going into the policy.
Liquidity conditions stable
Liquidity, as measured by the bids for reporeverse repo in the Liquidity Adjustment Facility (LAF) auction conducted by the RBI, was down last week with the daily average LAF bids accepted by RBI for reverse repo at 5.75% at Rs 45,592 crore against Rs 47,025 crore the previous week. There was no bid for repo at 6.75% last week. The last day of the week saw RBI sucking out Rs 46,070 crore from the system by accepting reverse repo bids in the LAF. Daily weighted average call money rates were flat at 5.80% levels, while repo levels were in 5.60-5.70% range. Liquidity is expected to be ample this week and overnight rates should hover around last week’s levels, unless there is a rate hike in the review of the policy.
Government securities
Government bond prices closed sharply higher last week as the markets focused on a rally in US treasuries on the back of a dovish statement by Bernanke who warned against taking rates up too far. This gave the markets hope that there will be no rate hike at the Fed’s August meeting. The benchmark 10-year bond, 7.59% 2016, closed last week at 8.24% levels, down 10bps week-on-week, while the long bond, 7.40% 2035, closed flat at 8.89% levels.
The benchmark five-year bond, 9.39% 2011, closed the week at 7.75% levels, down 11bps week-on-week. The well-traded 7.94% 2021 bond saw yields going down by 11bps from 8.66% to 8.55% week-on-week.
Government bonds retraced all the losses seen in the week before last when the RBI devolved an auction on primary dealers. Volumes were lower in the bond market last week with daily volumes in the government bond market averaging Rs 1654 crore last week against Rs 1824 crore the previous week. Inflation as measured by the changes in the Wholesale Price Index came in around market expectations for the week ended July 8, 2006. Inflation came in at 4.68% against market expectations of 4.66%.
Treasury bills
The 91-day Treasury bill (T-bill) auction on July 19, 2006 saw a cut-off of 6.43% against a cut-off of 6.40% seen in the previous auction. The 364-day T-bill auction saw a cut-off of 7.02% last week against a cut-off of 7.05% seen in the previous auction. Treasury bills traded better after the auction cut-offs with yields on the 91-day T-bill falling by 10bps and the yields on the 364 day T-bills falling 15bps, as the markets rallied on the back of falling US treasury yields. T-bills would follow the policy action this week.
Corporate bonds
Corporate bonds saw a large number of banks lining up for Tier II issues to shore up their capital adequacy ratios. The issues are for maturities ranging over 10 years and are all expected to be priced over 9% levels or spreads of around 80-100 bps over the 10-year government bond.
Overnight index swaps (OIS)
The OIS market saw yields move down by around 10bps with the benchmark 5-year OIS yields closing last week at 7.29% levels against 7.38% seen in the previous week. The market saw some sort covering as payers scrambled to receive even as government bonds rallied.
The market will wait for any policy action for further direction.
The author is a portfolio manager with Patco Investments & Consultancy Services P Ltd and the views expressed herein are personal. Please e-mail feedback to
feedback@arjunparthasarathy.com
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