RBI did not deliver as expected by bond markets leading to long position unwinding. Bond markets were expecting a repo rate cut by the RBI in its 18th June 2012 policy review and those expectations fed into bond yields that had rallied by 15bps with the benchmark ten year bond, the 8.15% 2022 bond seeing yields drop to 8% levels from 8.15% levels. RBI’s status quo on rates took the yield on the 8.15% 2022 bond back up to 8.15% levels in a knee jerk reaction. However, OMO (Open Market Operations) by the RBI and falling oil prices globally improved market sentiments and the 8.15% 2022 bond closed the week at 8.08% levels, down 7bps from highs seen during and week and up 3bps on a week on week basis.
RBI’s status quo on policy rates took up yields at the short end of the curve, with three month treasury bill yields rising by 17bps week on week. One year bank CD (Certificate of Deposit) yields rose 10bps while the one year OIS yields rose 19bps week on week on rate cut disappointment.
The negative reaction by markets to the lack of rate cut will not last long as the market looks towards the July 2012 policy review of the RBI. Markets will start pricing in rate cuts in the July policy review as threats to domestic growth from troubles in the Eurozone increase. The worries of austerity measures in countries of Italy, Spain and France pulling down economic growth across the globe are being felt in commodity prices. Oil prices have dropped to lowest levels in over a year with Brent crude trading at USD 90/bbl, down from highs of USD 125/bbl seen over the last one year.
India’s economic data is not looking too robust with first quarter advance tax higher by just 4.9% year on year. Advance tax for the April- June 2012 quarter was at Rs 32,880 crores. Trade data for May 2012 showed a drop of 4% in exports and a drop of 7% in imports on a year on year basis. Total vehicle sales for the first two months of fiscal 2012-13 grew at 8.15% while passenger car sales growth was at 3.1%, both growth numbers indicating sluggish activity.
Inflation as measured by the WPI (Wholesale Price Index) is likely to trend down from levels of 7.55% seen in May. Inflation will fall on account of falling crude oil prices and lack of pricing power by manufacturers in a weak demand environment.
RBI has indicated in its June policy review that it will continue with its bond purchase operations to ease system liquidity. RBI held an Rs 12,000 crores OMO last week where it bought bonds worth Rs 11,300 crores. The total bond purchases by the RBI for fiscal 2012-13 is around Rs 78,000 crores. RBI bond purchases coupled with rate cut expectations in July will take down bond yields. Ten year benchmark bond yields will test lows of 8% and below in the coming weeks.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI tightened last week as advance tax money of around Rs 33,000 crores went out of the system. Bids for Repo averaged Rs 115,000 crores on a daily basis last week against an average of Rs 80,000 crores seen in the week before last. Government spending will bring the advance tax money back into the system in the coming weeks. RBI bond purchases will add to system liquidity. However if RBI had sold USD to prevent INR volatility with the INR touching all time lows of Rs 57.33, liquidity will be impacted negatively.
Government bond auctions and OMO’s
There 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% 2027 bond for Rs 2000 crores and the 8.83% 2046 bond for Rs 2000 crores. The cut offs came in at 8.17%, 8.37%, 8.46% and 8.63% respectively. The government is scheduled to hold an Rs 15,000 crores bond auction this week.
RBI bought bonds for Rs 11,300 crores last week in the OMO (Open Market Operation) purchase auction. The bonds purchased were the 8.24% 2018 bond for Rs 1889 crores at 8.19%, the 8.79% 2021 bond for Rs 5845 crores at 8.32%, the 8.97% 2030 bond for Rs 3402 crores at 8.52% and the 8.28% 2032 bond for Rs 170 crores at 8.52%.