The five year OIS yield is front running a potential fall in government bond yields in June.
The five year OIS (Overnight Index Swaps) yield closed last week at four month lows of 8.24%. The yield has come off by 38bps over the last one month. The spread between the five year OIS and five year government bond has widened from levels of 38bps to 52bps since the beginning of April 2014. The benchmark five year government, the 7.28% 2019 bond is trading at yields of 8.76%.
The spread between five year OIS and one year OIS has inverted to levels of 29bps from 3bps levels seen in beginning of April. One year OIS yield is at levels of 8.53%.
The downward movement in five year OIS yield indicates that markets are anticipating lower interest rates going forward. The push to lower interest rates would come from a strengthening INR, that is trading at around Rs 60 levels to the USD, up by over 3.5% over the last three months. The OIS curve is used by FIIs to trade Indian interest rates in the overseas markets, and the value of the INR has a bearing on the direction of OIS yields.
The reason the five year OIS yield has trended down much faster than the five year government bond yield is due to the fact that the supply of government bonds is heavy for the month of May. Government is auctioning bonds worth Rs 840 billion for the month. This week the government will auction Rs 200 billion of bonds, as it has to fund redemption of the 6.07% 2014 bond on The 15th of May for Rs 279.58 billion.
Going into June, the pace of government bond supply reduces with auctions worth Rs 460 billion scheduled for the month. Government bond yields could drop in June if the new government pledges support to rein in fiscal deficit and lower inflation expectations.
Government bond yields moved down between 1bps to 11bps week on week, as the market bought into higher levels of yields. Ten year benchmark bond the 8.83% 2023 bond saw yields closing down by 7bps at levels of 8.74%, while the well traded 8.28% 2027 bond saw yields fall 11bps to close at 8.99%. Government bonds will watch for the smooth sailing of the Rs 200 billion auctions to be held on the 16th of May before moving down.
Corporate bond yields fell by 5bps with benchmark five and ten year AAA rated bond yields closing at levels of 9.41% and 9.43% respectively. Five and ten year AAA credit spreads closed last week at 46bps and 50bps levels respectively. Five year credit spreads fell 1bps while ten year credit spreads rose 2bps last week. Corporate bond yields will be bid given that the market is buying into higher absolute levels of yields.
Liquidity eased last week as banks demand for funds were muted in the first week of the reporting fortnight. Banks borrowing from the RBI was at Rs 768 billion last week from Rs 985 billion seen in the week previous to last. Liquidity is likely to ease as government repays Rs 279 billion to investors in the 6.07% 2014 bond that matures on the 15th of May.