Improving liquidity conditions bode well for the corporate bond yield curve. The AAA corporate bond yield curve is flat with three, five and ten year bonds all trading at 9.50% to 9.55% levels. The curve will start steepening with three and five year yields falling faster than the ten year corporate bond yields. Credit spreads are also likely to trend down as the corporate bond yield curve steepens. Credit spreads as measured by the spread between AAA corporate bonds and the government bonds have come off on the back of improving liquidity conditions. Five and ten year AAA spreads have come off by 10bps and 20bps respectively over the last one month to trade at 104bps and 100bps respectively.
Liquidity conditions have improved considerably. Liquidity as measured by bids for repo at 7.5% in the LAF (Liquidity Adjustment Facility) auction of the RBI has come off from a daily average deficit of Rs 80,000 crores to a daily average deficit of Rs 16,000 crores week on week. Government spending, bond maturities, drop in notes in circulation, falling trade deficit and positive portfolio flows from abroad have all contributed to liquidity improving in the system. Government spending on salaries and other expenses in the beginning on every month adds liquidity into the system. Government bond outstanding of Rs 37,000 crores matured on the 2nd of July, and that money has come into the system. Notes in circulation have fallen by Rs 20,000 crores over the past one month on the back of cash held by the public going into bank deposits. Trade deficit has come down from USD 15 billion in May to USD 7.7 billion in June and this is positive for liquidity as there is less outflow of US Dollars from the system. Portfolio flows from abroad have turned positive with FII’s becoming net buyers of India equities in June and July from being net sellers in the previous months. FII’s have purchase over USD 2 billion of equities in June and July till date.
Corporate bond yields benefit from improving liquidity conditions as traders and investors look to lock on to the higher yields offered by corporate bonds over and above that of government bonds. Credit spreads at over 100bps provide a cushion from interest rate volatility. Liquidity conditions are likely to stay positive keeping corporate bonds bid.
Government bond yields closed flat week on week as the market digested Rs 15,000 crores of government bond auction, Rs 6000 crores of cash management bill auction and Rs 5250 crores of state government loan auction. The ten year benchmark bond, the 7.80% 2021 bond saw yields close flat week on week at 8.35%. The bond market will await the release of IIP (Index of industrial Production) and inflation data, which are to be released this week for cues on direction of interest rates. The government is trying to talk down yields saying that bond yields are unacceptably high and that the government may defer some auctions till yields come off. The bond market will not buy into that statement and will look at inflation trajectory over the rest of the year in taking bond yields up or down.
US benchmark ten year treasury yields fell 15bps week on week, as job addition for June was lower than expected. The US added 18,000 jobs in June against expectations of 105,000 jobs. Unemployment rate went up to a 2011 high of 9.2%. The US economy is in a sluggish growth environment. China’s inflation came in at 6.4% for the month of June against a 5.5% rate for May. China raised interest rates by 25bps before the release of the data. The ECB (European Central Bank) raised rates by 25bps as a signal on vigilance on inflation, which at 2.7% levels is trending higher than ECB target of 2%. The US Federal Reserve (Fed) will continue to maintain rates at all time lows while the ECB is expected to raise rates a couple of more times this year. China’s inflation is seen to have peaked and there are expectations that the PBOC (People’s Bank of China) will put a hold on rate hikes.
Government bond auction
The government auctioned Rs 12,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 3000 crores, the 8.13%% 2022 bond for Rs 6000 crores and the 8.28% 2027 bond for Rs 3000 crores. The cut offs came in at 8.38%, 8.48%, and 8.62% respectiveThe government is scheduled to auction Rs 12,000 crores of bonds this week.