Bond markets have nothing to look forward to for the next couple of months except bond auctions. The steady stream of supply will keep bond yields ranged at higher levels despite a positive surprise by RBI in its annual policy of 2012-13 held last week. RBI cut the repo rate by a higher than expected 50bps in the policy, leading to an initial euphoria in the bond markets, which took down bond yields by 10bps. However the euphoria died down quickly on the back of a lack of positive guidance by the RBI on further rate cuts and on the lack of follow through bond buying by the central bank. Bond yields rose from lows to close 10bps higher week on week. The ten year benchmark bond, the 8.79% 2021 bond saw yields trend down from levels of 8.47% pre policy to 8.34% post policy and closed the week at 8.57% levels.
RBI while delivering a higher than expected repo rate cut in its policy did not commit itself to more rate cuts going ahead. The central bank will watch for the behavior of oil prices globally and the effects of an expected hike in fuel prices on inflation before taking a fresh view on the growth-inflation trajectory. RBI has sounded out that a fuel price hike will not be taken negatively as it helps reduce the subsidy burden of the government as well as tempering the artificial demand created by subsidies. Monsoons will be another factor for the RBI on its future policy actions and if monsoons are on track, there will be less pressure on food price driven inflation.
Liquidity will be the primary focus of the RBI in the coming months. Given that the RBI is keen on keeping liquidity as measured by bids for repo/reverse repo in its comfort zone of around +/- 1% of NDTL (Net Demand and Time Liabilities), sharp deficits in liquidity will prompt the central bank to buy bonds to shore up liquidity. RBI has bought Rs 6360 crores of bonds this month as bond yields threatened to go higher on the back of liquidity worries amidst heavy government borrowing.
Liquidity deficit averaged around Rs 87,000 crores last week against an average of Rs 89,000 crores in the week before last. Liquidity deficit in an Rs 60,000 crores to Rs 100,000 crore band will be comfortable for the RBI. Banks have the leeway to borrow around Rs 420,000 crores from the RBI given the excess SLR of 5% and the access to 2% of SLR to avail of the MSF (Marginal Standing Facility).
The Indian Rupee (INR), which is trading at Rs 52.08 to the US Dollar (USD), will pose question marks on liquidity. The INR has fallen by over 6% against the USD over the last couple of months and if RBI sells USD to stem further falls in liquidity, system liquidity will go further into deficit. RBI is likely to buy government bonds to neutralize the liquidity impact of USD sales.
Money market security yields fell sharply post policy. Yields on 91 day and 364 day treasury bills fell 46bps and 17bps respectively in the auctions while one year bank CD (Certificate of Deposit) yields fell 25bps week on week. The fall in over night rates by 50bps post rate cut and the comfortable outlook for liquidity prompted the fall in yields on treasury bills and CD’s. Bank CD yields will trend down further as banks hold off raising money through CD issuances given the comfort given by the RBI on liquidity.
One and five year OIS (Overnight Index Swaps) yields rose week on week following the rise in government bond yields. One year OIS yields rose 3bps while five year OIS yields rose 7bps week on week and the five over one OIS spread came off by 4bps to close the week at a negative 38bps. The five over one OIS spread should trend towards zero given expectations of steady to lower repo rates, which is more positive for one year OIS yields than five year OIS yields.
Government bond auctions
The government auctioned Rs 16,000 crores of bond last week. The bonds auctioned were the 8.19% 2020 bond for Rs 4000 crores, the 9.15% 2024 bond for Rs 7000 crores, the 8.97% 2030 bond for Rs 2000 crores and the 8.33% 2041 bond for Rs 2000 crores. The cut offs came in at 8.44%, 8.50%, 8.74% and 8.81% respectively.
The government is auctioning Rs 16,000 crores of bonds this week.