Bond markets are exhibiting classical signs of an impending bull run. Falling bond yields amongst surging volumes and heavy demand for bonds in auctions point to a strong rally in bonds in the coming weeks. Bond yields are likely to trend down across the curve as the markets head into 3rd May 2013 RBI annual policy statement.
A bond rally is likely to take place on the back of the following factors. A) Banks have seen a surge in deposits in March 2013 and are buying bonds to maintain SLR (Statutory Liquidity Ratio B) RBI is expected to cut the repo rate by a minimum of 25bps in its 3rd May 2013 annual policy.
Banks have added Rs 3.74 lakhs crores in deposits in the month of March 2013 to boost their balance sheets for the fiscal year. The strong deposit growth in March saw banks demand for government bonds go up in April bond auctions as banks have to maintain a minimum of 23% SLR on their Net Demand and Time Liabilities (NDTL). Banks require to purchase Rs 86,000 crores of government bonds to cover for SLR for the March deposit growth. Even if banks are maintaining SLR at higher levels at over 25% of NDTL, the surge in March deposits is inducing banks to bid aggressively in bond auctions to cover SLR.
The second government bond auction of fiscal 2013-14 for Rs 15,000 crores held on the 12th of April saw bids amounting to over Rs 65,000 crores as banks rushed to fill their books. The heavy demand for the bonds in the auctions brought down bond yields across the curve. Bond yields fell 7bps to 13bps week on week on the back of demand for bonds by banks. The ten year benchmark bond the 8.15% 2022 bond saw yields fall 7bps while the 8.07% 2017 bond yield fell 13bps.
Banks will continue to bid heavily in the next few auctions as they look to shore up their bond holdings. The fact that traders were sitting on the fence at the beginning of April on worries of auction supply is contributing to the demand for bonds in the auctions. Trader books were light and with bond yields trending down, traders are being forced to fill up their books on worries of being left out of the rally. Banks are competing with traders for bonds in the auctions leading to bids becoming aggressive amidst heavy demand.
RBI is going into May 2013 annual policy setting in an environment of highly uncertain economic growth and weakening commodity prices globally. Data from March 2013 vehicle sales saw the first drop in sales growth for a fiscal in a decade and outlook for growth in fiscal 2014 is around 3% to 5%. IIP (Index of Industrial Production) growth for the April – February 2013 stands at 0.9% against a growth rate of 3.5% seen in the same period in the previous fiscal year. Demand outlook is clearly negative in India.
Brent crude oil price is down by over 6% over the last one month on the back of worries on global economic growth. IMF is likely to cut global growth forecast for 2013 from January 2013 forecast of 3.5% to 3.4% as spending cuts from US to China weakens demand.
Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI tightened by Rs 10,500 crores week on week with bids for repo averaging Rs 97,300 crores on a daily basis last week against an average of Rs 86,800 crores seen in the week previous to last. Banks covering their product in the first week of the reporting fortnight led to liquidity tightening. Liquidity is likely to ease in the coming weeks as banks demand for funds comes down in the wake of weak credit demand in the beginning of the new fiscal year.
Five and ten year benchmark AAA corporate bond yields fell by 10bps and 3bps respectively week on week to close at levels of 8.65% and 8.70% respectively. Corporate bond yields are likely to trend down on the back of a rally in government bond yields.
OIS (Overnight Index Swaps) markets saw the curve come off on the back of the fall in government bond yields. One and five year OIS yields fell by 5bps and 6bps respectively to close at levels of 7.38% and 7.15%. One year OIS yields are likely to fall further as outlook for liquidity is more positive than negative.