RBI came out with an OMO (Open Market Operation) sale auction announcement when the benchmark ten year bond, the 8.40% 2024 bond yield touched two months lows of 8.40%. The OMO for Rs 100 billion is scheduled for the 13th of October 2014.
The OMO announcement took up bond yields by around 5bps with the yield on the 8.40% 2024 bond closing at levels of 8.45%. The primary aim of the OMO is to suck out excess liquidity from the system but the bond market has an uneasy feeling that the RBI is uncomfortable with bond yields trending down given its inflation targeting policy.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) was in deficit of Rs 152 billion last week from Rs 186 billion seen in the week previous to last. Government is running cash surplus of around Rs 1000 billion and if it starts to spend, liquidity will ease significantly. System is well funded and liquidity is unlikely to tighten significantly in October despite festive season demand for funds.
RBI could well have resorted to stopping Term Repo auctions where it has lent funds for Rs 437 billion to the system. That would have taken liquidity into a deficit mode and kept overnight rates at around repo rate level of 8%. Other options include issuing MSS (Market Stabilization Scheme) bonds as RBI has infused Rs 880 billion through spot USD purchases in the April-August 2014 period.
Bond market is inclined to take a longer term view on yields and that view is highly positive. Falling inflation expectations on the back of sharp fall in commodity prices globally, improving domestic macro economic position and high levels of global liquidity will impact interest rates positively in the economy. Given this view, the market is positioning itself on the ten year plus maturity segment of the government bond yield curve. The curve is flat with ten year benchmark bond yield at 8.45%, fourteen year benchmark bond yield at 8.58% and thirty year benchmark bond yield at 8.66%. The bond market is comfortable with a flat curve and willing to ride out short term volatility for longer term gains.
Government bond yields fell week on week as markets bought into expectations of falling long term interest rates. The ten year benchmark bond, the 8.40% 2024 bond saw yields fall by 3bps to close at 8.45% levels. The ten year bond yield will look to trend down as market reacts positively to a poor IIP (Index of Industrial Production) data. IIP growth for August 2014 was at 0.4% against expectations of 2.4%.
OIS market saw the yield curve falling week on week on easing liquidity conditions. One year OIS yield fell 9bps while five year OIS yield fell 18bps to close at levels of 8.36% and 7.70% respectively. The Five over One OIS spread inverted by 9bps to close at negative 66bps levels. OIS yields will continue to trend down on expectations of lower interest rates going forward.