The cut-off on the new ten year benchmark government bond was aggressive at 7.16%. The market in its euphoria on rate cuts post a highly bond market positive inflation number drove down the yield on the new ten year bond that the government issued in its 17th May 2013 bond auction. The level of 7.16% on the ten year bond was last seen in November 2009.
The 7.16% 2023 bond has now changed the shape of the government bond yield curve. The one year treasury bill yield is 7.21%, the 7.83% 2018 bond is trading at yields of 7.31% and the 8.15% 2022 bond is trading at yields of 7.40%. The new ten year bond has caused a kink in the government bond yield curve. The bond market will now have to realign the yield curve to fit in with the aggressive cut off on the new ten year bond.
The question the market will be asking itself before it starts trading on the 20th of May is what will be the next benchmark bond the government will be issuing? The ideal candidate for a new benchmark bond will be in the twelve to fifteen year maturity period. The current on the run bonds in this maturity bracket are the 8.20% 2025 and 8.33% 2026 bonds that are trading at levels of 7.42% each. The market will look to bid at levels of 7.25% to 7.30% on the new twelve to fifteen year bonds if issued.
The government may also issue a new five year benchmark bond. The market will bring down the yield on the new five year bond to levels of 7.05% in order to steepen the on the run yield curve.
So what happens to the current well traded bonds, the 8.07% 2017, the 7.83% 2018, the 8.20% 2025 and the 8.33% 2026. Markets will trade these bonds aggressively despite new benchmarks being issued, as it will take a while to build floating stocks for the new bonds. Spreads between old and new bonds will be the game the market will play now.
Inflation as measured by the WPI (Wholesale Price Index) for the month of April 2013 came in at a three and half year low of 4.89%. The market was expecting inflation to print at levels of 5.5%. The sharp fall in inflation from March 2013 levels of 5.96% raised hopes of rate cut expectations in RBI’s June 2013 mid term review of monetary policy. RBI Governor D.Subbarao commented that the central bank will take note of falling inflation numbers leading to the market factoring in a 25bps repo rate cut in June.
Corporate bond yields fell by 25bps to 30bps across the curve on the back of falling government bond yields. Five and ten year benchmark AAA corporate bonds closed at around 8% levels last week. Ten year AAA bond spreads rose by 11bps week on week on the back of the low cut off on the new ten year government bond. Five year AAA bond spreads fell 12bps week on week on the back of the sharp fall in corporate bond yields. Corporate bond yields are likely to see further falls as the market searches for yields after the aggressive cut off on the new ten year bond yield.
OIS (Overnight Index Swaps) yields fell 10bps week on week on the back of falling government bond yields. One year and five year OIS yields closed last week at levels of 7.10% and 6.76% respectively. Rate cut expectations will drive one year OIS yields to below 7% levels in the coming weeks.
Liquidity as measured by bids for repo/reverse repo in the LAF (Liquidity Adjustment Facility) auction of the RBI averaged over Rs 100,000 crores on a daily basis last week. RBI will look to carry out OMO (Open Market Operation) bond purchase auctions to reduce the liquidity deficit, as June advance tax payments will increase the deficit in system liquidity.