The bond market is anxiously waiting for the government to announce an issue of a new ten year bond. The current ten year benchmark bond, the 8.15% 2022 bond is no longer a ten year maturity bond and with an outstanding issuance of Rs 76,000 crores the bond is close to RBI’s cap on single security outstanding amounts of Rs 80,000 crores. The new ten year bond auction announcement can come in this week, where the government is scheduled to auction Rs 15,000 crores of bonds.
The market will bid aggressively for the new ten year bond as traders and investors rush in to replace the old benchmark bond with the new one. The auction amount for the new ten year bond is likely to be Rs 7000 crores and demand for the auction is likely to be four to five times the auction size. The yield on the 8.15% 2022 bond was 7.75% as of last week and the cut off on the new ten year bond, when issued, will come in at 7.60% or even lower.
Bond markets had a bit of a scare last week when the RBI said there was limited space for further monetary actions this fiscal. However the RBI delivered a 25bps rate cut, meeting market expectations. RBI has again reiterated that there is limited space for further easing but the governor D. Subbarao has left an opening for the RBI if it believes that the current account deficit (CAD) and inflation expectations can come off. The CAD for the fourth quarter of 2012-13 will be released end June 2013 and the number is likely to print at levels well below the levels of 6.7% of GDP seen in the third quarter of fiscal 2012-13.
Inflation as measured by the WPI (Wholesale Price Inflation) is likely to print lower than levels of 5.96% seen in the month of March 2013. RBI has forecast that inflation will trend down in the first half of 2013-14.
A lower CAD coupled with inflation trending down leaves enough scope for the RBI to cut the repo rate in its July 2013 policy review.
The central bank has announced an OMO (Open Market Operation) purchase auction of Rs 10,000 crores to be held on the 7th of May 2013. Banks are continuing to borrow from the RBI on a daily basis largely due to the excess cash balances of the government that is parked with the RBI. OMO auction will further add to bullish bond market sentiments leading to bond yields trending down in the coming weeks.
Liquidity as measured by the bids for Repo in the LAF (Liquidity Adjustment Facility) auction of the RBI eased last week as banks demand for funds fell in the reporting week. Bid for repo averaged Rs 86,000 crores on a daily basis last week against an average of Rs 95,000 crores seen in the week before last. Liquidity will ease further in the coming weeks on the back of OMO purchase auctions.
Five and ten year benchmark AAA bond yields closed down 8bps and 10bps last week on the back of positive rate cut sentiments. Five and ten year credit spreads fell 5bps each to close at 55bps and 76bps levels. Five year spreads can come off given that its trading over 20bps higher than ten year spreads.
The OIS (Overnight Index Swaps) market saw five year OIS yields fall by 7bps week on week to close at 6.91% levels. One year OIS yields fell by 1bps to close at 7.22% levels. The five over one OIS spread inverted by 6bps to close at levels of 31bps. OIS yields are factoring in more rate cuts ahead.