Arjun Parthasarathy

The bond market faced tough conditions last week with oil prices touching record highs, the rupee depreciating sharply against the US dollar, and domestic inflation numbers coming in at higher levels.

Oil prices touched record highs last week with Nymex crude crossing $125barrel on geo political and liquidity factors. The dollar-rupee pair rose by over 2% week on week on strong demand from oil companies. Domestic inflation stayed at multi year highs with WPI (wholesale price index) rise coming in at 7.61% for the week ended April 26, 2008.

However, the market held steady, retaining most of the post-policy gains. It had seen a good rally post annual monetary policy on April 29, with yields coming off by 40bps.

The Reserve Bank of India (RBI) had surprised the market on the positive side, by maintaining status quo on benchmark rates while hiking the cash reserve ratio (CRR) by 25bps. The market was expecting the RBI to increase benchmark rates to bring down inflationary expectations.

The market, on holding steady under pressure, is confident that the RBI will not carry out any anti inflationary measures till the policy review in July 2008.

Bond yields closed the week marginally higher, with the ten-year benchmark bond yield closing up 2 basis points week on week at 7.87% levels.

However, intra week, bond yields recovered sharply from lows, with ten-year bond yields rising by 8 basis points from its lows of 7.79%.

The market chose to take profits at higher prices, with some shorts initiated at highs. The sharp post-policy rally, coupled with the inflationary environment, prompted the market to take some risk off the table at higher levels.

The coming week is expected to see the market circumspect, with oil prices, dollarrupee and inflation being watched closely. The absence of a dated market stabilisation scheme (MSS) bond auction is a positive for the market.

Liquidity as measured by bids for reverse repo repo in the liquidity adjustment facility (LAF) of the RBI saw bids for reverse repo at 6% ranging from Rs 23,000 crore to Rs 53,000 crore over the week.

Overnight rates hovered around the reverse repo rate. Liquidity is expected to tighten gradually given auction outflows and CRR hikes and overnight rates are likely to trend higher in the coming weeks.

Government bonds

Government bonds saw yields rise marginally week on week. The yield on the benchmark ten year 8.24% 2018 bond closed the week up 2 basis points at 7.87% levels.

Five-year benchmark bond yields were higher by 2 bps, with the yield on the 7.27% 2013 bond closing at 7.89% levels.

Yields on the long bond, the 8.33% 2036, closed higher by one basis point at 8.37% levels. The ten over thirty spread closed lower by a basis point at 50 bps levels.

The government held dated bond auctions for Rs 10,000 crore on May 9. The bonds auctioned were the 7.59% 2016 bond for Rs 6000 crore and the 7.95% 2032 bond for Rs 4000 crore. The auctions saw cutoffs coming in close to better than market expectations.

The cut-off on the 7.59% 2016 bond came in at 7.95% levels, which was a basis point below market expectations. The cut off on the 7.95% 2032 bond came in at three basis points above market expectations.

The auctions saw good investor demand while traders preferred to bid at higher yield levels given the off the run nature of the bonds.

Treasury bills, corporate bonds and overnight index swaps

Treasury bill (T-bill) yields were lower last week on good system liquidity. The cut-off on the 91-day T-bill auction held on May 7 came in at 7.31% against a cut-off of 7.35% at the previous auction.

The 364-day T-bill auction saw the cut-off at 7.55% against a cut-off of 7.69% seen in the previous auction. The RBI is auctioning Rs 3,500 crore of 91-day T-bills (of which Rs 3,000 crore is under regular auction and Rs 500 crore is under MSS) and Rs 2,000 crore of 182-day T-bills (of which Rs 1,000 crore is under regular auction and Rs 1,000 crore is under MSS).

Corporate bonds saw yields move higher as players took profits at lower levels. Fiveyear yields were trading in the 9.40% to 9.45% range, up by 5 bps week on week. Fiveyear AAA bond spreads were higher by 7 basis points week on week at 140 basis points levels.

The primary market saw Tata Steel place Rs 1,800 crore of bonds. The issue saw good interest, with the 7-year maturity paper placed at 10.20% levels while 3-year maturity paper were placed at 9.80% levels. The market may see more primary issues given restrictions on external commercial borrowing and given a weakening rupee.

Overnight index swaps (OIS) saw the swap curve steepen on good liquidity, high oil prices and depreciating rupee. One-year OIS yields moved up by a basis point to close the week at 7.20% levels, while five-year OIS yields closed higher by 11 bps at 7.30% levels. The one over five spread steepened by 11 bps week on week.

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 : DNA