Bond yields fell by around 5bps last week on the back of a sharp fall in five year OIS yields. Five year OIS (Overnight Index Swaps) yield fell 21bps week on week to close last week at 6.97% levels, the lowest close since September 2011. The rally in five year OIS yields is on the back of record low bond yields across markets globally. Bond yields from Germany to Japan closed at all time lows last week on worries of economic growth. US ten year treasury yields fell 6bps week on week to close near all time lows at 1.49%. The OIS markets tracks global bond and interest rate swap markets closely as the OIS curve is extremely active in overseas markets.
Hedge funds managers and proprietary traders in banks based outside India use the OIS yield curve for positioning in Indian interest rates and falling yield OIS yields suggest that their outlook on Indian rates is positive. Global fund manager views on rates are largely determined by both global factors and domestic factors. Globally the rally in bond yields suggests that growth and inflation will stay down long enough for central banks to keep rates at record lows and keep pumping in liquidity to the markets.
On the domestic front India is definitely facing a slowdown as seen by weak IIP (Index of Industrial Production) trends with IIP growth for May 2012 at 2.4% levels against a revised negative growth of -0.9% for April 2012 and against growth of 6.2% seen in May 2011. The fall in exports and imports in June 2012 by 5.5% and 13.5% year on year reinforce the economic slowdown in India. Inflation is the only factor that is clouding expectations of interest rates coming off as the WPI (Wholesale Price Index) is staying sticky at 7.5% levels. However if general inflation is stripped of food and fuel prices, the core inflation is below 5%.
The OIS market is front running RBI rate cuts, though expectations of rate cuts in the July 2012 policy are low. The market is betting on the fact that RBI will cut rates and the timing of rate cuts is not seen as important.
Inflation for the month of June 2012 is expected to come in at over 7.5% levels. If inflation prints at significantly below 7.5% levels, bond yields will rally sharply as rate cut expectations in July will increase
Liquidity eased last week with liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI averaging Rs 41,000 crores on a daily basis last week against an average of Rs 43,000 crores seen in the week before last. Liquidity outlook is benign as the factors driving liquidity including credit growth, trade deficit and government balances are positive for liquidity. Credit growth at 16.5% year on year in June 2012 is down from 18.7% seen in April 2012. Trade deficit is down 23% month on month as of June 2012. Government is running an overdraft of around Rs 6200 crores with the RBI indication spending.
Government bond auctions and OMO’s
The government auctioned Rs 16,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 4000 crores, the 8.15% 2022 bond Rs 6000 crores, the 8.97% 2030 bond for Rs 3000 crores and the 8.33% 2036 bond for Rs 3000 crores. The auction was well received by the market with the bid to cover ratio at 2.8 times, which is higher than the average of just over 2 times seen over the last few months. The cut offs came in at 8.01%, 8.10%, 8.50% and 8.59% respectively. The government is scheduled to auction Rs 15,000 crores of bonds this week.