Oil, liquidity to determine market trend

In the near future, liquidity may be squeezed on festival demand for currency

The Reserve Bank of India (RBI) raised the cash reserve ratio (CRR) by 50bps effective on November 10 in the mid-term review of the annual monetary policy held last week.

The hike was unexpected and bond yields rose while the swap curve flattened on liquidity fears. Ten-year benchmark bond yields rose 8bps after the hike, while the one over five swap curve flattened by 12bps.

Corporate bonds saw benchmark AAA yields moving higher by 10bps. However, when RBI rejected the bids for the MSS ( market stabilisation scheme) component in the treasury bill auctions, bond and swap yields regained some of their losses.

The mild reaction by the market to the unexpected CRR hike suggests that the market is comfortable with the absolute levels of yields.

The medium-term outlook for liquidity is positive as the CRR hike is expected to negate portfolio flows. However, the scope for yields falling in the near term is low as high oil prices (crude at over $90/bbl)  has raised RBI concerns on inflation. Liquidity may also be squeezed in the near term on festival demand for currency, busy season credit offtake and auction outflows. 

The US Federal Reserve (Fed) cut benchmark rates by 25bps and signalled that this may be the last of the cuts for a while. The higher-than expected US payroll number (non-farm payrolls came in at 166,000 job additions against expectations of 110,000) strengthens the view on low probability of further cuts. US benchmark 10-year year treasury yields rose 12bps after the Fed cut on inflation fears. However yields came off sharply to close the week at 4.34% levels, down 3bps week on week. The US bond markets will look for inflation numbers to seek direction on yields. 

Liquidity as measured by bids for reverse repo/ repo in the LAF (liquidity adjustment facility) of the RBI was down week on week. Bids for reverse repo at 6% last week  was at Rs 7,100 crore levels against over Rs 18,000 crore seen in the week before last. Overnight rates hovered around reverse repo rates of 6%. Overnight rates are expected to trend higher given the negative outlook for liquidity in the near term. 

Government bonds
Government bond yields closed higher week on week. The yield on the benchmark ten year bond 7.99% 2017 bond closed higher by 5bps to close at 7.86% levels. Five-year benchmark bond yields closed higher by 1bps with the yield on the 7.40% 2012 bond closing at 7.76% levels. Yields on the long bond the 8.33% 2036 bond closed flat at 8.32% levels. The five over thirty segment of the curve was almost unchanged. 

The RBI held government bond auctions under the MSS last week. The MSS auction of 5.87% 2010 bonds for Rs 3,000 crore and the 11.30% 2010 bonds for Rs 3,000 crore saw the cutoff yields come in higher than the previous auction cut offs. The cutoffs came in at  7.73% for the 5.87% 2010 bond and at 7.80% for the 11.30% 2010 bond, higher by 7bps and 4bps respectively. RBI is not auctioning dated bond under MSS this week. 

The RBI has announced government bond auctions under the government borrowing programme for this week. The bonds to be auctioned are the 8.20% 2022 bonds for Rs 5,000 crore and the 8.33% 2036 bonds for Rs 3,000 crore. The  8.20% 2022 bond will have to see price discovery given that its rarely traded. 

T-bills, corporate bonds and overnight index swaps
Treasury bills (T-bills) yields were higher week on week on the back of CRR hike. The cut off on the 91 day T-bill auction held on the 31st of October came in  at 7.31% against a cutoff of 7.02% seen in the week earlier to last. The 182 day T-bill auction saw the cutoff coming in at 7.58% against 7.45% seen in the previous auction. The RBI rejected the bids for the MSS component of the auctions.

The rejection may have been due to the bids at higher yields and due to the outlook for liquidity. The RBI is auctioning Rs 3,500 crore of 91-day and Rs 3,000 crore of 364-day T-bills this week, including Rs 3000 crore of 91-day and Rs 2,000 crore of 182-day T-bills under MSS (market stabilisation scheme) 

Corporate bonds saw five year benchmark bonds yields move higher  by over 10bps week on week on the back of the CRR hike. The five-year AAA bonds were quoting at 9.15%-9.20% levels. The five year AAA spreads closed at around 130bps levels higher by 5bps week on week. Credit spreads are likely to take direction from liquidity and supply. 

Overnight index swaps (OIS) saw swap yields move higher on the back of the CRR hike.

The one year OIS yield rose  21bps to close last week at 7.18% levels. The five year OIS yield closed higher by 8bps at 7.22% levels. The one over five spread closed at 4bps, lower by 13 bps week on week. The curve will look to invert on strained liquidity conditions.

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.