Bond market has largely factored in a 25bps repo rate cut in the RBI policy meet on the 29th of January 2013. Ten year benchmark bond yields are down 22bps month to date on rate cut expectations and on improved sentiment on government finances post fuel price decontrol. The benchmark ten year bond the 8.15% 2022 bond is trading at levels of 7.88% and the bond yield is unlikely to fall from these levels if the RBI cuts the repo rate by 25bps.
The ten year bond might even see yields rise on a 25bps rate cut as markets are looking at Rs 48,000 crores of government bond auctions in February 2013. Heavy supply in February coupled with budget for 2013-14 scheduled for end February will prompt profit taking in bonds as traders lighten up to absorb the bond supply.
Bond markets will take down bond yields if the RBI cuts the repo rate by 50bps. The yield on the 8.15% 2022 bond can fall by 25bps on a 50bps rate cut, as the market will then factor in more rate cuts in 2013. Markets will also take the 50bps rate cut by the RBI as a thumbs up signal by the Central Bank to the Government on its efforts on fiscal consolidation.
A 50bps rate cut by the RBI will also signal that RBI is becoming more comfortable on inflation expectations. Inflation as measured by the WPI (Wholesale Price Index) is expected to trend below 7% levels as against RBI expectations of 7.5%. The market will read a 50bps rate cut, as “RBI is fine with living with temporary inflation upticks due to the pass through of administered prices into the economyâ€.
RBI has helped bond markets by purchasing Rs 47,000 crores of government bonds through OMO (Open Market Operations) in January to add liquidity into the system. The government rescheduled January bond auctions to February to alleviate tight liquidity conditions. Bond markets have seen floating stock go out of the market in January and that has helped drive down bond yields. Hence in effect, RBI by easing the repo rate by 50bps is giving a huge fillip to the bond markets to drive down bond yields.
The question is will RBI cut the repo rate by 25bps or 50bps on the 29thof January 2013? The answer is that RBI is more likely to cut the repo rate by 50bps and bond markets should go long into the policy on expectations of higher than expected rate cuts.
Liquidity tightened last week as banks demand for funds increased in a holiday shortened reporting week. Â Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids average Rs 97,000 crores on a daily basis last week against an average of Rs 88,000 crores seen in the week before last. Liquidity is likely to stay at levels of around Rs 100,000 deficit in the coming weeks as government borrowing takes away funds from the system.
Corporate bond yields rose week on week on the back of profit taking at lower levels of yields. Five and ten year benchmark AAA bond yields closed at levels of 8.75% and 8.73% up by 5bps and 1bps respectively. Corporate bond yields are likely to come down on rate cut expectations.
OIS (Overnight Index Swaps) markets saw the OIS yield curve unchanged week on week. One and five year OIS yields closed flat at 7.56% and 7.15% levels respectively. One year OIS yields will fall sharply on the back of a 50bps rate cut.