The first half of fiscal 2012-13 will see bond supply through government bond auctions averaging Rs 15,000 crores a week. The government is to borrow a gross amount of Rs 569,000 crores in fiscal 2012-13 of which around 65% will be completed in the first half of the fiscal year. First half borrowing will be around Rs 370,000 crores. Auction sizes will range from Rs 13,000 crores to Rs 18,000 crores. The government is keen to elongate the maturity of its borrowings, and maturities of bonds auctioned will be concentrated in the ten to twenty year bucket.
Bond yields will struggle to stay at current levels of 8.40% on the ten year benchmark bond once the borrowing starts. There will be initial hiccups in the bids for the auctions as investors bid cautiously in the initial auctions to weigh the demand for bonds. Markets will also wait for the RBI annual monetary policy for 2012-13, which is scheduled for released on the 17th of April, before taking a directional call on interest rates.
Ten year benchmark bond the 8.79% 2021 bond yield should close at 8.5% and higher levels on the 31st of March 2012, which is the end of the fiscal year. Markets will prefer to take bond yields higher before the auctions hit the market in April.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) of the RBI will ease in April. Bids for repo averaged Rs 162,000 crores last week as advance tax outflows and year end demand for money hit the system. Bids for repo are likely to come off to levels of Rs 75,000 crores and below in the second week of April. Government spending and release of excess funds by the banking system will ease liquidity in April. Improving liquidity in the system will help bring down yields on money market securities. Three month bank CD (Certificate of Deposits) yields, which are trading at close to 11.5%, will drop sharply to levels of 9%. One year bank CD yields that are trading at 10.7% levels will drop to levels of 9.75%. Three month treasury bill yields will drop to levels of 8.5% from 8.98%.
Corporate bonds yields will remain steady at levels of 9.4% on the benchmark five and ten year AAA bonds. The pressure on government bond yields on the back of bond auctions will keep corporate yields sticky at higher levels leading to spreads coming off. Five and ten year AAA credit spreads will drop by 10bps from current levels of 77bps and 84bps respectively.
The OIS (Overnight Index Swap) curve will lose its inversion going into April. Easing liquidity coupled with pressure on government bond yields due to borrowing will pull down one year OIS yields and push up five year OIS yields. One year OIS yields are trading at 8.12% while five year OIS yields are trading at 7.52% and the five over one spread is a negative 60bps. The spread should trend down to zero in the next couple of months and if RBI reduces repo rates in its April policy, the curve will even look to steepen sooner than expected.