Weak domestic growth data, record low US and German bond yields, sharp fall in commodity prices and RBI bond purchases have set the stage for a smart rally in bond yields. Ten year benchmark bond yields fell 14bps last week to close the week at 8.37% levels and will trend down in the coming weeks on expectations of rate cuts by the RBI in its June mid quarter monetary policy review.
The bond rally will get a further boost when the government issues a new ten year benchmark bond to replace the current ten year benchmark bond the 8.79% 2021 bond, which has an outstanding amount of Rs 83,000 crores. RBI sets a limit for the outstanding amount on a single bond to reduce stress on the system when the bond comes up for maturity and the current threshold limit is seen in the Rs 80,000 crores to Rs 90,000 crores range. Bond yields can potentially fall by 25bps on the issuance of the fresh ten year bond.
The weak fourth quarter 2011-12 GDP growth data has the bond markets factoring in repo rate cuts in RBI’s 18th June 2012 policy review. GDP growth came in at a nine year low of 5.3% for the fourth quarter, dragging down the full year 2011-12 growth to 6.5% from earlier estimates of 6.9%.
The fall in GDP growth has been accompanied by weak economic data and risk aversion trades taking down US treasury and German bund yields to record lows. Ten year US treasury yields fell to it’s lowest ever close on record at 1.45% on the back of weak job addition numbers in the US. The US economy added 69,000 jobs in May against expectations of 150,000 job additions. Unemployment rate rose to 8.2% in May from 8.1% in April.
German two year bund yields fell to below zero percent on the back of investors fleeing out of indebted Eurozone nation debt to the safety of German debt. Ten year bund yields closed last week at all time low levels of 1.17%. In contrast to German bond yields, Spain’s ten year bond yields rose to levels of 6.6% on worries of debt repayment capacity of Spain.
The worries on economic growth brought about by poor growth data from India, weak job numbers from the US and contraction in manufacturing in May in Germany and the Eurozone prompted a sell off in commodity markets. The benchmark commodity index, the Reuters CRB index fell 5% week on week and has fallen over 22% on a year on year basis. Oil prices fell 8% over the week to close at their lowest levels in over six months.
RBI has been buying bonds in the secondary market and through OMOs (Open Market Operations) to shore up liquidity in the system. RBI has bought around Rs 50,000 crores of bonds fiscal year to date and RBI’s bond purchases have reduced the floating stock of government bonds in the market.
The market was sitting light on bonds on worries of government bond supply (weekly supply averaging around Rs 16,000 crores for the first six months of the fiscal year) and liquidity, which is negative with banks borrowing from the RBI on a daily basis. The market was also not expecting any rate cuts by the RBI in June post the 50bps rate cut in April. However the fresh economic date has changed the equation and markets are expecting rate cuts in June, and this has prompted hectic filling up of books.
The OIS curve lost most of its inversion last week on the back of rate cut expectations. One year OIS yields moved down by 34bps week on week while five year OIS yields moved down by 19bps. The five over one OIS spread closed at a negative 37bps last week with the inversion coming off by 15bps. The OIS curve will look to start steepening soon as the markets start factoring in more rate cuts going forward.
Government bond auctions and OMO’s
The government auctioned Rs 15,000 crores of bonds 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 8.28% 2032 bond for Rs 2000 crores and the 8.83% 2041 bond for Rs 2000 crores. The cut offs came in at 8.32%, 8.43%, 8.65% and 8.73% respectively.
The government is auctioning Rs 15,000 crores of bonds this week.
There was no OMO auction held last week.