The government auctioned the much awaited new ten year benchmark bond last week and the cut off came in at bullish levels of 8.40%. We had suggested a cut off of 8.50% for the new ten year bond in our weekly analysis last week. The bond started trading in the When Issued market at 8.43% and touched lows of 8.36% before the auction cut off came in at 8.40%. The old ten year benchmark bond, the 8.83% 2023 bond that has gone off the run traded at levels of 8.67%, 27bps higher than the 8.40% 2024 bond. The other two on the run bonds, the 8.27% 2020 bond and the 8.60% 2028 bond are trading at levels of 8.41% and 8.56% respectively.
The outlook for the 8.40% 2024 bond is bullish as the market builds long positions in the benchmark ten year bond on expectations of inflation coming off and government showing commitment to FRBM (Fiscal Responsibility and Budget Management) act. Core CPI inflation for June 2014 came in at levels of 7.40%, down from levels of over 8% seen in the previous months. CPI is expected to trend down further in the coming months on base effect, RBI maintaining an anti inflation policy and government curbing expenditure and controlling food prices through administrative measures.
RBI is expected to sound positive on inflation expectations in its policy review on the 5th of August. The central bank will also laud government’s efforts to control fiscal deficit and focus on lowering inflation. RBI will primarily look to manage liquidity to meet the system’s needs in the coming months.
RBI tweaked limits for FIIs in government bonds by reallocating USD 5 billion of government bond limits from long term investors such as sovereign funds, pension funds and insurance companies to FIIs. There is no lock in period for the investments though minimum maturity of governments bonds is three years residual maturity. FIIs would fill this limit quickly given that there is a global search for yields as seen by record lows levels of junk bond yields in US and Europe.
Five and ten year AAA credit spreads rose by 9bps and 30bps week on week to close at levels of 67bps each last week. Ten year spreads rose sharply due to the change in benchmark bond from 8.83% 2023 to 8.40% 2024 bond for calculating credit spreads. Five and ten year AAA corporate bond yields fell 9bps and 5bps to close at levels of 9.28% and 9.23% respectively. Credit spreads will look to stabilize at current levels of yields.
OIS market saw one year OIS yields staying flat and five year OIS yields falling by 1 bps to close at levels of 8.41% and 7.90% respectively. The five over one OIS spread inverted by 1bps to close at negative 51bps levels. Five year OIS yields are likely to trend down on bullish auction cut off of 8.40% on the new ten year benchmark bond.
Liquidity tightened last week as bank borrowing from RBI in repo and term repo auctions increased by Rs 25 billion week on week. Bank borrowing from the RBI was Rs 115 billion last week. Outlook for liquidity is stable with RBI managing deficits through term repo auctions.