Bond Market Snapshot For The Week
· RBI continues Operation Twist While Government does Bond Switches
· 10-year benchmark bond, 6.45% 2029, yield rose by 4 bps to 6.63%
· 5 year OIS yields rose by 7 bps to 5.62%
· Liquidity continues to be in a huge surplus of Rs 4.10 trillion
The government has done bond switches worth Rs 2.24 trillion, fiscal 2019-20 year to date to ease the repayment of bond maturities that are coming up over the next two years. On the switch, the government has issued Rs 700 billion of the new 10 year benchmark bond, the 6.45% 2029 bond, apart from other medium to longer dated bonds. Read our note on Bond Switches for details.
RBI in the last one month has conducted three Twist auctions and is conducting the fourth Twist auction this week. Total Twist auction amount including this week’s auction is Rs 400 billion. RBI is effectively buying the 6.45% 2029 bond, that is issued by the government in its switches. Read our note on Operation Twist to understand the Twist operations.
Bond markets are caught between government issuing 10 year bond and RBI buying the 10 year bond. Effectively, RBI is preventing the markets from shorting the 10 year bond on the back of inflation worries and worries over the state of government finances, that are in a deep mess with a hole estimated at over Rs 2 trillion for this fiscal year. CPI inflation for December 2019 came in at 7.35%, well over RBI’s target of 4% +/- 2%. This effectively rules out any rate cuts by the RBI in the next few policy meets.
Bond yields are being held down artificially by the RBI and the market has no appetite for bonds given that the government is likely to announce a huge borrowing program for the next fiscal year, as it looks to pump prime the economy. Bond yields held artificially low prevents investors from factoring in fundamentals and when RBI stops buying the 10 year, yields will shoot up and cause a huge loss to investors who are buying bonds at artificial levels.
Bond markets will increasingly use the OIS curve to execute negative rate views and the spreads between the government bonds and OIS will compress sharply and will flatten out. The spread between the 5 year OIS at 5.62% and 5 year government bond at 6.40% is at 78bps and this spread will tend to flatten with 5 year OIS yields rising sharply higher.
The benchmark 10-year bond, the 6.45% 2029 bond, yields increased by 4 bps to 6.63% on a weekly basis. The benchmark 5-year bond, the 6.18% 2024 bond, yield came down marginally by 1 bps to 6.40% while 7.17% 2028 bond yield rose by 1 bps to 6.88%. Similarly, 7.63% 2059 yield level gained 5 bps 7.14% on a weekly basis.
One-year OIS yield came down by 2 bps to 5.37% while the five-year OIS yield increased by 7 bps to 5.62% on a weekly basis.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facility (MSF or Marginal Standing Facility) was in surplus of Rs 4100 billion as of 17th January 2020. Liquidity was in a surplus of Rs 3952.4 billion as of 10th January 2020.