Corporate bond yields at the short end of the yield curve fell sharply last week as the market bought into attractive yields at higher levels in anticipation of good system liquidity in April 2014. One, two and three year benchmark AAA corporate bond yields fell by 10bps to 30bps on expectations that yields would drop sharply in April.
This week is the last week of fiscal 2013-14 and the whole banking system is focused on liquidity. The last trading day of this month is 29th of March as 31st March is a holiday on account of a local festival. Banks require to maintain sufficient cash balances as of the year end as well as show good credit/deposit growth profile. Corporates and individuals will be getting their accounts in order and cash requirement increases at the end of the fiscal year. Hence the system tends to hoard liquidity and funds become costlier for entities that require liquidity.
RBI is holding a term repo auction for Rs 200 billion on the 28th of March and is also opening the MSF (Marginal Standing Facility) window on the 31st of March for banks that require last minute funds. The system is currently borrowed Rs 1490 billion from the RBI indicating the high fund requirement. The system is borrowed Rs 400 billion in the LAF (Liquidity Adjustment Facility), Rs 91 billion under MSF and Rs 1000 billion in term repos.
Given the high liquidity requirement in March, yields at the short end of the curve tend to rise. 91 days treasury bills yields are trading at close to five months highs at levels of 9.2% while one year bank CD (Certificate of Deposits) yields had gone up to six months high levels of 9.90%. Yields on one year CD have come off by 50bps from highs on the back of the market buying for April.
The overall environment for liquidity is positive. The INR has held its own despite the Fed sounding out rate increases in 2015 and is trading steady at Rs 61 to the USD. FIIs have bought close to USD 6 billion of INR bonds in the first three months of calendar year 2014. Foreign exchange reserves are up by USD 20 billion over the last six months. Bank deposits growth has increased pace from levels of 13% seen seven months ago to levels of 15.6% as of March 2014. Inflow of USD 34 billion into FCNR B deposits on the back of RBI swap facility has shored up both reserves and deposits.
The government has been instrumental in liquidity tightening in the system despite strong flows. Government has stopped spending and has collected around Rs 90 billion in disinvestments in March and over Rs 500 billion of advance tax. The government had enough cash to buy back around Rs 150 billion of its own bonds. (Rs 100 billion were bought last week and Rs 50 billion buyback is scheduled for this week). Government will spend going forward and government cash surplus should be seen as a short term phenomenon.
Government bond yields closed almost flat last week as the market kept away from directional bets before the release of the borrowing calendar for first half of fiscal 2014-15 that is expected this week. Market would also wait for RBI policy on the 1st of April 2014 before taking calls on yields.
Five and ten year benchmark AAA corporate bonds yields were steady last week as the market focused on the short end of the yield curve. Credit spreads were flat. Corporate bond yields are likely to come off in April as market buys into higher levels of absolute yields leading to a decline in credit spreads, as government bond supply will keep government bond yields in check.
OIS (Overnight Index Swaps) market saw the curve shift up before RBI policy on 1st April. One year OIS yield rose by 1bps while five year OIS yield rose by 4bps to close at levels of 8.66% and 8.51% respectively and the five over one OIS spread flattened by 3bps to close at 15 bps levels. OIS yield curve is likely to flatten on the back of better liquidity conditions going forward.