Bullish cut-off on new bond to steepen yield curve

The government auctioned a new 13-year bond in its bond auction on the September 21. The cut-off on the bond maturing in 2025 came in at 8.20% levels, just 2 basis points (bps) higher than the traded levels of 8.18% on the benchmark ten-year bond, the 8.15% 2022 bond. The market bid aggressively for the new paper, the auction amount of which was Rs7,000 crore, on expectations of the yield curve shifting down. A falling yield curve takes up bond prices and the longer the maturity of the bond the higher the price gains.

The near-term factors for the bond market are bullish. The government has indicated it will stick to its budgeted borrowing for the fiscal 2012-13. The diesel price hike and more fiscal consolidation measures to be taken in end-October 2012 are expected to keep the fiscal deficit in check. The government will raise Rs199,000 crore in the second half of fiscal 2012-13 as it will have completed Rs370,000 crore of borrowing in the first half of the fiscal. The total gross budgeted borrowing for fiscal 2012-13 is Rs569,000 crore. Bond markets were worried about the government exceeding its budgeted borrowing for the fiscal on the back of rising subsidy bills and slowing tax collections due to a weakening economy. The market will not have to worry about extra borrowing for at least three months, as the government will review its finances for more borrowings at the beginning of calendar year 2013.

The expectations of a repo rate cut in the October 30, 2012, policy review of the RBI are high given the fact that the RBI stated in its September 17 policy review that economic growth will be given importance going forward. The RBI cut cash reserve ratio by 25 bps in its September policy review to infuse Rs17,000 crore of liquidity into the system. Reserve Bank of India (RBI) expects liquidity to be pressured due to advance tax outflows, busy season credit offtake and festive season demand for currency.

Liquidity tightened last week on the back of second quarter 2012-13 advance tax outflows. Liquidity, as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI, saw bids for repo averaging Rs71,000 crore on a daily basis last week against an average of Rs43,000 crore seen in the week before last. Advance tax outflows led to the higher bids for repo. The advance tax that went out of the system will come back into the system through government spending. The government has been running an overdraft with the RBI, having borrowed Rs13,100 crore from the RBI through ways and means advances (WMA) as of September 14, 2012. The government requirement for funds are high as it has to compensate oil marketing companies for losses sustained in selling fuel at subsidised prices. The subsidy outgo is running at over Rs45,000 crore in the first five months of the current fiscal.

The expectations of repo rate cut and easing liquidity conditions have driven down yields on money market securities and short term corporate bonds. One-year bank certificate of deposit (CD) yields have dropped below 9% levels from levels of 9.5% seen a couple of months back. Triple A rated corporate bonds in the two to five year maturity segments have seen yields drop by 25 bps over the last couple of months. The market is looking to buy into higher absolute levels of yields in corporate bonds on expectations of an easier interest rate regime going forward.

Overnight index swaps (OIS) market saw yields drop across the curve on the back of improved bond market sentiments. One and five year OIS yields fell by 4 bps each last week. One-year OIS yields are likely to see more receiving on expectations of rate cuts and easing liquidity conditions. 

Government bond auctions
The government auctioned Rs15,000 crore of bonds last week. The bonds auctioned were the 8.19% 2020 bond for Rs4,000 crore, the new 13-year bond for Rs7,000 crore, the 8.28% 2032 bond for Rs2,000 crore and the 8.83% 2041 bond for Rs2,000 crore. The cut-offs came in at 8.25%, 8.20%, 8.58% and 8.55%, respectively. The government is scheduled to auction Rs15,000 crore of bonds this week.

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