Arjun Parthasarathy 
 
The Reserve Bank of India (RBI) surprised the market on the positive side by maintaining status quo on benchmark rates in its annual monetary policy for 2008-09 on Tuesday.

The central bank hiked the cash reserve ratio (CRR) by 25 basis points (bps) to suck out excess liquidity. It has hiked the CRR by 75 bps over the last two weeks, a move that will suck out Rs 27,000 crore from the system.

The market was expecting the RBI to increase benchmark rates in the policy to bring down inflationary expectations, which is trending at elevated levels. The market expected a hike in the repo rate by 25 bps to 8%.

The market took the CRR hike as a positive and rallied sharply post policy. Bond yields came off by 25 bps on short-covering and relief buying.  Bond yields had risen sharply over the last two weeks on expectations of rate hikes by the RBI in the policy. Ten year benchmark bond yields had touched highs of 8.24% on interest rate fears. The bond rallied smartly post policy to close the week at 7.85% levels, down 40 bps from highs.

The coming week is expected to see the market looking to sustain the rally, given that immediate fears of interest rate hikes are gone. Government bond auctions for Rs 10,000 crore may see good bidding interest, given positive interest rate sentiments. Inflation numbers, even if coming in at higher levels, may not deter the market from its positive outlook.

Inflation as measured by the wholesale price index (WPI) came in at 7.57% for the week ended April 19, 2008, against expectations of 7.42%, which the market shrugged off.

Liquidity as measured by bids for reverse repo repo in the liquidity adjustment facility (LAF) of the RBI saw bids for reverse repo ranging from Rs 4,300 crore to Rs 20,000 crore over the week. Overnight rates hovered around the reverse repo rate of 6%. Liquidity is expected to tighten given auction outflows and CRR hikes and overnight rates are likely to trend higher in the coming weeks.

Government bonds

Government bonds saw yields sharply down week on week. The ten-year bond (8.24% 2018) yield closed lower by 30 bps at 7.85% levels. Five-year benchmark bond (7.27% 2013) yield was lower by 22 bps at 7.87% levels. Yield on the long bond (8.33% 2036) closed lower by 23bps at 8.36% levels. The ten over thirty spread closed higher by 8 bps at 51 bps levels, while the five over ten spread inverted to 2 bps.

The market stabilisation scheme auction (MSS) for Rs 3,000 crore of 6.57% 2011 bonds saw the cut-off coming in at 7.87% against a cut-off of 8.08% in the previous auction. There are no MSS auctions scheduled for this week.

The government has announced dated bond auctions for Rs 20,000 crore to be held on the May 9. The auctions are as per the borrowing calendar for the first half of fiscal 2008-09. The bonds to be auctioned are the 7.59% 2016 bond for Rs 6,000 crore and the 7.95% 2032 bond for Rs 4,000 crore. The auctions are expected to sail through, though the curve is expected to inverse at cut offs.

Treasury bills, corporate bonds and overnight index swaps

Treasury bill (T-bill) yields came off last week on positive surprise in the policy. The cut-off on the 91-day T-bill auction on April 30 came in at 7.35% against a cut-off of 7.44% at the previous auction. The 182-day T-bill auction saw the cut-off at 7.45% against a cut-off of 7.60% in the previous auction.

The RBI is auctioning Rs 3,000 crore of 91-day T-bills under regular auction and Rs 3,500 crore of 364-day T-bills (of which Rs 1,000 crore is under regular auction and Rs 2,500 crore is under MSS) this week.

Corporate bonds saw yields move down across the curve owing to the post-policy positive sentiment. Five-year yields were trading in the 9.35-9.40% range, down 25 bps week on week. Five-year AAA bond spreads were lower by 7 bps week on week at 133 bps levels.

One-year papers also saw yields come off by around 50 bps as fears of higher short rates vanished. Corporate bond spreads at the longer ends are likely to remain stable given positive interest rate sentiments.

Overnight index swaps (OIS) saw the swap curve fall and flatten after the policy. One-year OIS yields moved down by 21 bps to close last week at 7.19% levels, while five-year OIS yields closed lower by 29 bps at 7.19% levels. The one over five spread flattened completely. OIS yields are likely to trend down given positive interest rate sentiments.

The author is head, portfolio management services, Sundaram BNP Paribas AMC Ltd. The views expressed by the author are his own and need not represent the views of the organisation in which he works.

Source : DNAIndia