Bond market reaction to rate cuts by the ECB (European Central Bank) and PBOC (People’s Bank of China) was muted as the market is more focused on domestic factors of inflation and liquidity. ECB cut rates by 25bps and the PBOC cut lending rates by 31bps last week. The move by ECB was expected but the PBOC cut was a surprise to the markets, as the central bank had last cut rates in June 2012. Bond markets in India do sometimes react positively to rate cuts across the globe but this time markets stayed indifferent to the rate cuts and bond yields hardly moved on the news. Bond markets are not expecting RBI to lower their guard against inflation and follow other global central banks in sharply reducing policy rates.
Bond yields closed lower week on week on the back of better than expected cut off on the new fourteen year bond and on the back of easing liquidity conditions. The ten year benchmark bond the 8.15% 2022 bond saw yields close down 2bps week on week to 8.15% levels. The new fourteen year bond that was auctioned last week saw the cut off come in at 8.33%, 6bps lower than the levels traded in the when issued market. The positive cut off on the 8.33% 2026 bond suggest that bond markets are eager for fresh on the run bonds as pricing and trading such bonds is easier than trying to find a level for bonds going off the run. The market now has three new benchmark bonds to trade, the 8.07% 2015 bond, the 8.15% 2022 bond and the 8.33% 2026 bond, leading to higher trading activity in the coming weeks.
Liquidity eased last week with liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI averaging Rs 43,000 crores on a daily basis last week against an average of Rs 89,000 crores seen in the week before last. Liquidity eased despite last week being the first week of the reporting fortnight where banks look to over cover their product. Liquidity eased on the back of government spending on salaries and other such heads in the first week of the month.
Easing liquidity conditions brought down yields on money market securities with one year CD (Certificate of Deposit) yields falling 10bps week on week. Money market security yields are likely to trend down further on the back of easing of concerns on liquidity. Banks have hardly seen any deposit or credit growth (both close to zero percent growth) in the April-June 2012 period while RBI has infused primary liquidity of Rs 79,000 crores into the system through government bond purchases. RBI’s liquidity infusion will be felt in the coming weeks given that credit has not picked up.
The OIS (Overnight Index Swaps) market saw the yield curve fall with one and five year OIS yields moving down 6bps and 3bps week on week respectively. Improved outlook on liquidity helped OIS yields move down and the curve is likely to see its inversion come off from current levels of 57bps if liquidity trends towards the positive side.
RBI for the first time released an indicative borrowing program by the state governments. State governments are expected to borrow around Rs 36,000 crores to Rs 40,000 crores in the July-September 2012 quarter. The level of state government borrowing is reasonable and will not impact bond markets in terms of supply and liquidity.
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 for Rs 4000 crores, a new 14 year bond for Rs 6000 crores, the 8.28% 2032 bond for Rs 2000 crores and the 8.33% 2041 bond for Rs 3000 crores. The cut offs came in at 8.21%, 8.33%, 8.55% and 8.65% respectively. The government is scheduled to auction Rs 16,000 crores of bonds this week.