The RBI will have to announce a bond purchase program if it wants to improve system liquidity as well calm nervous markets. Liquidity, which is tight at present, is expected to get tighter in December 2011 on the back of advance tax outflows. Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI, saw bids for repo average Rs 120,000 crores on a daily basis last week. Liquidity has tightened by around Rs 80,000 crores since October 2011 and will tighten further as advance tax money goes out of the system in mid December 2011.
The RBI held an Rs 10,000 crores bond purchase auction last week in order to improve system liquidity. The RBI has not given an OMO (Open Market Operation) purchase schedule and last week’s OMO was ad hoc. The market will look to the RBI for indication of further liquidity easing measures through OMO’s. If the RBI does not announce more OMO’s in the coming week, bond yields will rise sharply on worries of liquidity and supply.
Last week’s OMO helped bring down bond yields at the six to thirteen year segment of the curve. The RBI bought bonds worth Rs 9435 crores through the purchase auction. The bonds purchased were the 7.99% 2017 bond for Rs 649 crores, the 7.83% 2018 bond for Rs 2288 crores, the 7.80% 2021 bond for Rs 3802 crores and the 8.13% 2022 bond for Rs 2695 crores. The bonds were purchased at cut off yields of 8.77%, 8.79%, 8.82% and 8.86% respectively. The fact that the OMO’s bonds are in the six to twelve year segment of the curve is making the market shun long bonds in the government bond auction.
The government bond auction of Rs 13,000 crores last week saw the yield curve steepen as the market showed a distinct lack of appetite for the long bond the 8.30% 2040 bond. The 8.30% 2040 bond, which was auctioned for Rs 3000 crores, saw the cut off come in at 9.28%, taking yields on the bond higher by 7bps week on week. The benchmark ten year bond the 8.79% 2021 bond saw yields fall by 4bps week on week on the back of OMO’s. The rise in yields in the 2040 bond and the fall in yields in the 2021 bond steepened the ten over thirty segment of the yield curve by 11bps. The yield curve will steepen further at the longer end if the RBI buys back bonds at the six to twelve year segment of the curve and the government continues to sell bonds at the long end of the curve.
The government auctioned floating rate bonds last week in order to improve market sentiments. The floating rate bond auction saw the cut off come in at lower levels in terms of price, as the market is unsure on the pricing of the bonds. The 2020 floater is benchmarked to the 182 day treasury bill and the right way of pricing the bond is to find out the price of an interest rate swap with the maturity matching the maturity of the 2020 floater and the floating rate being the 182 day treasury bill. The distortions in the yield curve in the Indian bond markets make swap pricing extremely difficult and hence the market bids wildly for floating rate bonds.
The auction for Rs 3000 crores of the 2020 floater saw the underwriting commission fixed at Rs 0.1399 as against a commission of Rs 0.0221 fixed for the 9.15% 2024 bond. The cut off came in at Rs 93 for the Rs 100 face value bond. The steep discount to the face value in the 9 year maturity bond shows the uncertainty on the pricing of the bond by the market.
Corporate bonds saw yields come off week on week with yields on benchmark AAA five and ten year bonds coming off by 5bps and 3bps respectively. Corporate bond yields fell in tandem with government bond yields. The yields at the short end of the curve rose on liquidity worries with one year money market security yields rising by 7bps week on week. Money market yields are likely to move up on the back of liquidity fears.
Interest rate swap curve moved higher week on week on liquidity fears. One and five year OIS (Overnight Index Swaps) yields rose 4bps and 8bps respectively. OIS yields are likely to be pressured as liquidity tightens further.
Government bond auctions
The government auctioned Rs 13,000 crores of bonds last week. The bonds auctioned were the 2020 floating rate bond for Rs 3000 crores, the 9.15% 2024 bond for Rs 6000 crores and the 8.30% 2040 bond for Rs 3000 crores. The cut offs came in at 10.01%, 8.99% and 9.28% respectively. The RBI devolved Rs 103 crores of the floating rate bond on to the underwriters.