Government bonds will react positively to the reduction in size of the scheduled government auction from Rs 9,000 crore to Rs 4,000 crore.
Government bonds will react positively to the reduction in size of the scheduled government auction from Rs 9,000 crore to Rs 4,000 crore. The lower size of the auction, coupled with easing liquidity, should ensure at least a 15 bps rally in bonds.
However, profit-taking at higher levels should take away part of the gains as the market turns circumspect on higher US treasury yields (10-year benchmark yields rose 4 bps on a higher than expected job data) and expectations of rate hikes by the Reserve Bank of India (RBI).
The market was expecting a cut in the size of the auctions, which led to a rally of 8 bps in the beginning of the week. However, easing liquidity put paid to some of the hopes and yields went up by 4 bps from the lows. The last day of the week saw bonds trading positively on lower oil prices and easing liquidity and 10-year yields closed at the 7.54% levels, a gain of 7 bps week-on- week.
The announcement of a reduction in the auction size came after market hours, and this week will see the market open with a gap.
Liquidity
Liquidity, as measured by the bids for repo/reverse repo in the liquidity adjustment facility (LAF) auction conducted by the RBI, turned positive last week from being in the negative the week before last.
The daily average LAF bids accepted by the RBI last week for reverse repo at 6% was Rs 10,537 crore against the Rs 711 crore in the earlier week. Daily average bids accepted by the RBI for repo at 7.25% was Rs 2,178 crore against Rs 24,528 crore.
The last day of the week saw the RBI sucking out Rs 5,185 crore from the system by accepting reverse repo bids in the LAF. Overnight call and repo rates came off sharply from double-digit levels to close the week at 7.5% and 7.7%, respectively.
This week is expected to see liquidity tighten with the second leg of the cash reserve ratio (CRR) hike kicking in on January 6, and expected outflows on account of the Rs 4,000 crore bond auction to be held on January 12. Overnight rates are expected to trade in a 7.5-8% band.
Government securities
Government bond yields rallied last week on easing liquidity, falling oil prices and expectations in the reduction in the size of bond auctions. Ten year benchmark bonds saw yields fall by 7 bps week-on-week. Five-year bond yields were lower by 8 bps while long-bond yields fell by 7 bps. The yield curve steepened by around 4 bps. The benchmark 10-year bond — 8.07%, 2017 bond, closed last week at the 7.54% levels — down from the 7.61% levels seen in the week before last. The benchmark 5-year bond — 7.40%, 2012 bond — saw yields fall by 8 bps to close last week at the 7.43% levels.
The yield on the benchmark 8.33%, 2036 bond was lower by 7 bps at the 7.68% levels. Volumes were higher in the bond market last week with daily volumes in the government bond market averaging Rs 4,545 crore last week against the Rs 1,499 crore the previous week. Inflation as measured by the changes in the wholesale price index (WPI) came in higher than market expectations for the week-ended December 23, 2006. Inflation came in at 5.48% against expectations of 5.43%.
The government announced a bond auction for Rs 4,000 crore to be held on January 12, 2007. The bond to be auctioned is the 8.33%, 2036 bond. The auction size was cut from the scheduled Rs 9,000 crore as per schedule in the auction calendar. The government cited its comfortable liquidity position for reducing the auction size. The reduction in auction size is a big relief for the markets as liquidity was expected to tighten on account of auction outflows and CRR hikes. The auction is expected to see good demand across the market — from banks for statutory reserves, from insurers and provident funds, for statutory requirements and traders for building books.
Treasury bills
The 91-day Treasury bill (T-bill) auction on January 3, 2007, saw a cut-off of 7.14% against a cut-off of 7.19% seen in the previous auction. The 364- day T-bill auction saw a cut-off of 7.19% last week against a cut-off of 7.24% seen in the previous auction. T-bill yields were lower as liquidity and overnight money market rates eased. T-bills could see higher demand given easing liquidity.
Corporate bonds
Corporate bond spreads moved higher as falling government bond yields and rising corporate bond yields took spreads up. The benchmark 5-year AAA credit spreads went up by 6 bps week-on-week to close the week at 120 bps levels. Corporate spreads are expected to increase on increase in borrowing costs on account of tight liquidity, coupled with stable to falling government bond yields.
Overnight index swaps
The overnight index swaps (OIS) market saw yields all over the place with five-year OIS yields falling 7 bps initially during the week and rising by 13 bps from lows to close the week at the 7.48% levels. One year OIS yields moved violently, falling 9 bps and rising 19 bps from the lows. The OIS curve inverted further with the five-over-one OIS spread ending the week at a negative 11 bps from negative 4 bps seen in the week earlier to last. The OIS market should normalise as government bonds rally on the back of a reduction in size of the government bond auction.
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