The government has agreed to release Rs 45,000 crores of subsidy payments to oil companies for the subsidy bill of 2012-13. The funds paid to oil companies will improve system liquidity. Liquidity as measured by daily average bids for repo in the LAF (Liquidity Adjustment Facility) of the RBI was in deficit of around Rs 97,000 crores last week. Liquidity deficit was Rs 103,000 crores in the week before last.
RBI had conducted an OMO (Open Market Operation) bond purchase auction for Rs 10,000 crores on the 7th of May 2013, where it accepted bids for Rs 9658 crores. The RBI had conducted the OMO to infuse liquidity into the system that was in deficit due to high government cash surplus of around Rs 100,000 crores. The release of Rs 45,000 crores to oil companies will lower the government cash surplus and system liquidity will improve as the money comes into the banking system.
RBI is unlikely to conduct more OMOs, as liquidity is likely to improve on the subsidy payment. June first quarter advance tax payment will temporarily take out liquidity, but the money will come back into the system on government spending.
The improvement in system liquidity along with expectations of rate cuts in RBI June or July policy reviews will bring down yields at the short end of the yield curve. The yield curve is inverted at the ten over one segment of the government bond yield curve with one year treasury bills trading at 7.20% levels, five year government bond yield at 7.26% levels and ten year on the run benchmark bond yield at 7.11% levels. Improved system liquidity along with repo rate expectations at 7% levels will bring down yields at the short end.
The credit curve is also inverted with one year benchmark CD (Certificate of Deposit) yields at levels of 8.15% and five and ten year AAA corporate bond yields at 7.95% levels. Banks had raised deposits of Rs 374,000 crores in March 2013 and have lost Rs 52,000 crores of deposits in April. Credit has dropped by Rs 54,000 crores in April and banks are not stressed for liquidity. Easing system liquidity along with rate cut expectations should look to flatten the credit curve.
OIS (Overnight Index Swaps) market should see the one year OIS yield trend below 7% levels from current levels of 7.10% on the back of rate cut expectations and easing system liquidity. Five year OIS yields at 6.76% have already factored in a 25bps rate cut.
Government bond market saw yields drop by 5bps on the new ten year benchmark government bond the 7.16% 2023 bond. The 7.16% 2023 bond yield closed last week at 7.11% levels. The yield on this bond is likely to trend to 7% and below levels on the back of rate cut expectations.
Bond markets shrugged off a weak Rupee that lost 1.4% against the USD last week. The Rupee closed at its lowest levels since September 2012 on the back of a strengthening US Dollar Index. A weak currency is associated with outflow of US Dollars that is liquidity negative and hence bond yields tend to rise on currency worries. The fact that bond yields came off last week in the face of a weak Rupee suggest that the bond market is not worried about a sustained fall in the Rupee.