Bond markets will take rate cuts positively but will take rate cut expectations more positively. RBI indicating more cuts in July will bring down ten year bond yields to levels of 7.75%. OIS (Overnight Index Swap) yield curve will look to start steepening with one year OIS yields falling faster than five year OIS yields. Money market security yields will fall with one year CD (Certificate of Deposit) yields trending down from current levels of 9.5%.
The bond market is going into RBI’s mid quarter policy review on a distinctly bullish note. The new ten year bond, the 8.15% 2022 bond saw yields going below psychological levels of 8% last week before climbing back by 6bps to close the week at 8.05% levels down 11bps week on week. Bond market volumes hit record highs last week indicating the bullish sentiments prevailing in the market.
Bond market sentiments are positive on the back of RBI bond purchases and on the back of expectations of policy rate cuts by the central bank. RBI has bought over Rs 67,000 crores of governments bonds April 2012 to date and the bond purchases have helped absorb weekly government bond supply of Rs 15,000 crores and helped infuse liquidity into the system. System liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI has eased from deficits of over Rs 100,000 crores to deficits of Rs 80,000 crores over the last couple of months. Liquidity could ease further on the back of government spending and more bond purchases by the RBI.
RBI will release the mid quarter monetary policy review at 11am on the 18th of June. Markets are expecting some form of easing, from a CRR (Cash Reserve Ratio) cut to a repo rate cut. The quantum of rate cut expectations range from 50bps to 100bps on CRR and 25bps to 50bps on repo. The question is, will one policy document determine the future direction of bond yields?
The fact is that RBI has been easing policy steadily over the last six months and a rate cut(s) on the 18th of June policy review can easily wait.
RBI has infused liquidity worth Rs 135,000 through government bond purchases since the beginning of calendar 2012 of which Rs 67,000 crores have been in the new fiscal 2012-13. RBI’s CRR cut of 125bps since January 2012 has infused Rs 80,000 crores into the system. Total liquidity infusion through government bond purchases plus CRR cuts in the first six months of 2012 is Rs 215,000 crores. RBI has been lending around Rs 85,000 crores to Rs 100,000 crores on a daily basis to the system through the LAF (Liquidity Adjustment Facility) window, adding on to the system liquidity infusion.
The central bank cut Repo rates by 50bps in April 2012 though minutes of the TAC (Technical Advisory Committee) suggest that majority of the members were not in favor of the rate cut. RBI ‘s actions suggest that it has been addressing the growth slowdown issues through liquidity infusion and a 50bps rate cut in April. The central bank will use the June policy review to highlight its actions done earlier and rather than cut rates now it will indicate more rate cuts in its July policy review.
Inflation at 7.55% levels is still above RBI’s comfort zone though markets are talking about core inflation, which is below 5% levels. Inflation as measured by the WPI (Wholesale Price Index) came in at 7.55% levels for the month of May 2012 against 7.23% levels seen in April 2012. Hike in MSP (Minimum Support Price) for crops by the government will place more pressure on inflation. RBI may want to wait and watch on monsoon progress and full effect of fuel and MSP price hikes on inflation and hold policy rates status quo in June.
Government bond auctions and OMO’s
There was no government bond auction held last week. Government bond auction for Rs 15,000 crores is scheduled for this week.
RBI bought bonds for Rs 11,200 crores last week in the OMO (Open Market Operation) purchase auction. The bonds purchased were the 8.19% 2020 bond for Rs 4555 crores at 8.15%, the 8.79% 2021 bond for Rs 5653 crores at 8.31%, the 8.08% 2022 bond for Rs 993 crores at 8.35% and the 7.35% 2024 bond for Rs 5 crores at 8.28%.