The last month of the first half of fiscal 2012 is a tough month for bond markets. The markets have to contend with government bond supply, liquidity, RBI mid term policy review and the release of the borrowing program for the second half of fiscal 2012-13. The market will stay cautious going into September and ten year benchmark bond yields will traded in a 8.15% to 8.25% range in the coming weeks. The ten year benchmark bond the 8.15% 2022 bond closed almost flat last week at 8.21% levels.
The government is coming close to the end of its first half borrowing with Rs 61,000 crores of borrowing left of the total of Rs 370,000 crores of borrowing scheduled for the April-September 2012 period. Bond markets look for respite on borrowing in September given expected tightness in liquidity conditions due to second quarter advance tax payment, but there is no respite this time for the markets with Rs 46,000 crores of bonds scheduled to be auctioned. The continuous supply of bonds will keep markets nervous on the absorption of the supply, which is all the more impacted by the SLR (Statutory Liquidity Ratio) cut effected by the RBI in its July 2012 policy review. The SLR cut lowers demand for bonds as banks are required to maintain less government bonds as statutory reserves.
Liquidity will tighten in September as banks hoard liquidity to shore up their ALM (Asset Liability Management) for the end of the first half of the fiscal year. Advance tax outflows for the second quarter will also impact liquidity temporarily. Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI averaged Rs 40,600 crores on a daily basis last week and this deficit is likely to increase in September due to higher demand for funds by the banking system.
RBI mid term policy review is scheduled for mid September and the markets are still divided on rate cut expectations. RBI is non committal on rate actions despite clear signs of a weakening economy with GDP growth forecasts being revised downwards by the government from 7.6% to 6.7% for 2012-13. The below normal monsoons this year will pull down GDP growth further if the impact is high on the agricultural sector.
The government will finalize its second half of 2012-13 borrowing program by the end of September. The markets are expecting additional borrowing given the pressure on the government’s finances due to a weakening economy. The extent of additional borrowing will drive markets going forward but till the borrowing is announced, markets will be nervous.
Interest rate swap market saw yields steady with five year OIS (Overnight Index Swap) yields and one year OIS yields closing almost flat at 7.15% and 7.82% levels respectively. OIS yields are likely to stay in a narrow range given that the curve has risen by 25bps over the last one month and there are no strong cues driving the markets at these levels.
Corporate bond yield curve is starting to steepen from being inverted to flat for almost one and half years. The AAA yield curve is normalizing with one, two, five and ten year bond yields at levels of 9.1%, 9.15%, 9.20% and 9.25% respectively. One year CD (Certificate of Deposit) yields could briefly come under pressure given expected liquidity tightness in September but this will not last for long. The AAA yield curve will steepen down the line given that medium term liquidity pressure on the market is not strong.
Government bond auctions
The government auctioned Rs 15,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 4000 crores, the 8.15% 2022 bond for Rs 6000 crores, the 8.97% 2030 bond for Rs 3000 crores and the 8.33% 2036 bond for Rs 2000 crores. The cut offs came in at 8.19%, 8.20%, 8.56% and 8.57% respectively. The government is scheduled to auction Rs 15,000 crores of bonds this week.