Auction cut-off augurs well for markets

Bond markets closed last week on a positive note, with the auction cut-off on the 7.49% 2017 bond coming in above market expectations. The better-than-expected cut-off enabled bonds to end the week off lows, though week-on-week, bonds ended in negative territory. The 7.49% 2017 bond closed last week at 8.28% levels from levels of 8.43% seen earlier during the week. The week also saw the Reserve Bank of India (RBI) holding two auctions of the 7.49% 2017 bond.

The first auction for Rs 5,000 crore on June 12 was outside the regular borrowing programme of the government, while the second auction for Rs 6,000 crore on June 15 was as per the schedule given in the auction calendar for the first half of fiscal 2007-08. The market, which was taken by surprise by the government’s increased borrowing, bid cautiously on the Rs 5,000 crore auction, and the cut-off came in at 8.44%. The market was also swayed by rising US Treasury yields (benchmark ten-year Treasury yields rose to 5.27% from 5.15% levels in the beginning of the week, but later fell back to 5.15% levels at the end of the week) and cut-off worries on the second bond auction on June 15.

However, as the week progressed, the market started buying into higher yields on the back of steadying US Treasury yields, ample domestic liquidity and falling inflation (inflation as measured by the Wholesale Price Index came in at 4.80% for the week ended June 2 against the previous week’s level of 4.85%). This led the market to bid better in the second auction, leading to better-than-expected cut-off.

This week is expected to see the market continuing the post-auction cut-off rally, given that there are only treasury bills and state loan auctions scheduled for the week. The rally in US Treasuries after a weaker-than-expected inflation number and reduced fears of further liquidity sucking measures by the RBI after advance tax outflows by the end of the week will add to sentiments.

Liquidity, as measured by the bids for reverse repo in RBI’s liquidity adjustment facility (LAF), was ample even after auction outflows of Rs 42,500 crore over the last two weeks. Bids for reverse repo at 6% were over Rs 35,000 crore in each auction. Overnight rates were held down by ample liquidity with call at around 3% levels and repo at below 1% levels. This week is expected to see liquidity reducing on account of advance tax outflows (expected at around Rs 15,000-20,000 crore) and scheduled treasury bills and state loan auctions for around Rs 10,000 crore. Overnight rate may remain soft, though trending up from lows.

Government Bonds

Government bond yields rose week-on-week, with the ten-year benchmark bond 8.07% 2017 bond closing the week higher by 2bps at 8.16% levels, while yields on the long bond, the 8.33% 2036, closed flat at 8.57% levels. The five-year benchmark bond, the 7.40% 2012, saw yields move higher by 6 bps and closed at 8.08% levels. The yield curve flattened week-on-week with the five over thirty spread moving up down by 6 bps to close the week at 48 bps spread.

T-bills, corporate bonds and OIS

Treasury bills saw higher auction cut-off on account of higher supply. The 91-day T-bill auction held on June 11 saw a cut-off of 7.73%, while the cut-off on the auction held on June 13 came in at 7.77%. This was against a cut-off of 7.23% seen in the week earlier to last. The 182-day T-bill auction on June 11 and 13 saw the cut-off coming in at 7.81% against 7.62% seen in the previous auction. This week will see the RBI auctioning T-bills for Rs 6,500 crore.

Corporate bonds saw quiet trading with all the action focused on government bonds on account of the auctions. Credit spreads moved in tandem with government bond yields with five-year benchmark spreads at around 185 bps levels. Crisil’s downgrade of on Hindalco (AAA to AA) was the highlight of the week. Credit spreads will remain pressured as balance sheets reflect higher leverage and falling credit profile.

Overnight index swaps (OIS) saw the one over five curve flatten by 21bps on the back of rise in short-end yields. The one-year OIS yield closed last week at 7.94%, higher by 24 bps week-on-week, while the five-year OIS yield closed at 8.03% levels from 8% levels. Five-year OIS could see receiving on the back of an expected rally in government bonds.

The author is Head Portfolio Management Services Sundaram BNP Paribas AMC Ltd. The views expresed by the author are his own and need not represent the views of the organisation in which he works