RBI is causing more confusion for markets at a time when there is extreme nervousness. The Central Bank rejected all bids for the 7.73% 2034 bond and the 7.06% 2046 bond in the government bond auction last week. RBI had first rejected bids for the long bonds in the auction on 5th January and then accepted all bids in the auction on 12th January at much higher levels of yields. Bond markets are confused on the signals the central bank is sending out, whether it wants to signal that it is uncomfortable with higher levels of yields or whether it signaling that the government has enough cash and can afford to reject bids at higher yields in the auctions.
The government in response to fast rising bond yields that saw the new 10 year bond, the 7.17% 2028 bond yield rising by 19bps to 7.36% levels in just over a couple of weeks, cut its additional borrowing requirement of Rs 500 billion to Rs 200 billion. Government is running surplus cash and is also expected to receive extra dividend from the RBI. Bond yields fell by over 10bps on the back of the borrowing cut but climbed by 5bps from lows on worries of the budget.
Knee jerk reaction by the RBI and the Government does more harm than good for bond yields as the market views the moves as an artificial prop to bonds. Volatility increases, traders bring down trading positions leading to fall in volumes and yield movements will be amplified, which will unnerve investors.
RBI should signal its policy intentions rather than signal any yield intentions while the government should address fiscal deficit and inflation concerns.
The old 10 year benchmark government bond, the 6.79% 2027 bond, and saw yields rise by 17bps week on week to close at levels of 7.47% while the new benchmark 10 year bond, 7.17% 2028 bond, saw yields rise by 1bps to close at 7.29%. The on the run bond, the 6.79% 2029 bond saw yields close 8bps up at 7.46% levels and the 6.68% 2031 bond saw yields close up by 2bps at 7.57%. The long bond, the 7.06% 2046 bond saw yields close up by 3bps at levels of 7.66%. Gsec yields would trend up going into the budget.
The OIS market saw 5 year OIS yields closing 4bps lower week on week at levels of 6.74%. The one year OIS yield closed down by 3bps at 6.43%. OIS yield curve will steepen on the back of bond market worries.
Corporate bonds saw 5 year AAA corporate bond yields close up by 1bps at levels of 7.81% and 10 year AAA corporate bond yields close up by 2bps at 7.97%. 5 year AAA spreads fell by 3bps at 40bps and 10 year AAA spreads rose by 1bps at 58 bps. Corporate bond yields will rise slower than government bond yields on the back of high system liquidity.
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) and MSS/CMB bond issuance was in surplus of Rs 1335 billion as of 19th January 2018. The surplus was Rs 1505 billion as of 12th January. Currency in circulation has risen by Rs 620 billion in the last fortnight leading to drop in surplus liquidity.