The government should be issuing a new ten year benchmark bond in its Rs 140 billion bond auction scheduled for the 25th of July 2014. The current ten year benchmark bond, the 8.83% 2023 bond, has an outstanding of Rs 830 billion and is close to the threshold limit of around Rs 900 billion, when the government stops reissuing the bond.
The market is pricing out the 8.83% 2023 bond. The bond is trading at yields of 8.77%, higher than levels of 8.63% on the 8.60% 2028 bond and levels of 8.73% on the 9.23% 2043 bond. Continuing issuance of 8.83% 2023 bond does not make sense given the kink in the yield curve.
The market wants a new ten year benchmark to trade now. Given that the Budget 2014 has not shown a higher borrowing program and that inflation looks to be cooling down with core CPI (Consumer Price Index) inflation for June 2014 coming off to levels of 7.4% from levels of around 8%, the outlook for bond yields is more positive than negative. Demand will be strong for the new ten year benchmark bond and auction cut off could well exceed expectations.
The cut off on the new ten year benchmark bond in the auction is likely to be at levels of around 8.50% or even lower. The fact that SDL auction held on the 8th of July saw cut offs below 9% levels, suggest than ten year bond should ideally trade at 8.50% levels, given normal SDL spreads of around 50bps. Yields of around 8.63% on the 8.60% 2028 bond also indicate that ten year benchmark bond yield should be around 8.50% or even lower.
Credit spreads would rise on the issuance of the new ten year benchmark bond. Ten year AAA benchmark credit spreads are at levels of 32bps as yields of 9.28% on the ten year AAA corporate bond is priced off annualized yields of 8.96% on the 8.83% 2023 bond. Ten year credit spreads will rise to levels of over 50bps post cut off of 8.50% expected on the new ten year government bond.
Five year AAA benchmark credit spreads closed at 58bps with five year AAA corporate bond yields trading at levels of 9.38%. Five year credit spreads have gone up by 20bps over the last two weeks, post the sell off on corporate bonds after the introduction of new capital gains tax rule for debt mutual funds.
OIS market saw one year OIS yields falling by 1bps and five year OIS yields falling by 2 bps to close at levels of 8.41% and 7.91% respectively. The five over one OIS spread inverted by 1bps to close at negative 50bps levels. Five year OIS yields are likely to trend down on bullish auction cut off on a new ten year benchmark bond.
Liquidity tightened marginally last week as bank borrowing from RBI in repo and term repo auctions increased by Rs 20 billion week on week. Bank borrowing from the RBI was Rs 917 billion last week. Outlook for liquidity is stable with RBI managing deficits through term repo auctions. RBI held a 7 day term repo auction for Rs 100 billion on the 18th of July, which saw cut off at 8.15%.