The surprise issue of a new ten year benchmark bond in the government bond auction held on the 22nd of November has shifted the markets focus to yield curve spreads. The cut off yield on the new ten year bond that was auctioned for Rs 7000 crores was 8.83%. The old ten year benchmark bond the 7.16% 2023 bond traded at yields of 9.09%, which is a spread of 31bps from last week’s closing levels of 8.78% on the newly issued 8.83% 2023 bond.
The market has too many issues for it to play yield curve direction. Worries on repo rate hike in the RBI December 2013 policy review, Fed tapering off asset purchases, higher than budgeted government borrowing and elections are preying on the markets mind. However given that yields have backed up by 167bps from the time the 7.16% 2023 bond was issued in May 2013 to the 8.83% 2023 bond issued in November 2023, the market is not too comfortable taking the yield curve higher form current levels.
RBI too has been selectively pushing down yields by conducting OMO (Open Market Operations) purchase auctions. RBI held a Rs 8000 crores OMO on the 18th of November when bond yields were trending higher on worries of Fed taper and repo rate hikes.
The well traded bonds on the yield curve are the 8.28% 2027 bond, the 7.16% 2023 bond, the 8.12%2020 bond and the 7.28% 2019 bond and they are trading at yields of 9.11%, 9.09%, 8.99% and 8.91% respectively. The new benchmark ten year bond the 8.83% 2023 bond is trading at levels of 8.78%. One bond that is on the run but is not seeing good trading is the 9.20% 2030 bond that is trading at levels of 9.10%.
The market will have to decide the best bonds on the curve to trade. The 8.28% 2027 bond has an outstanding of Rs 68,000 crores and still has at least three more issuances to go before it hits the Rs 90,000 crore outstanding limit. The government will not issue more bonds once the outstanding bond issuances hit Rs 90,000 crores. The fact that 8.28% 2027 bond and the 7.16% 2023 bond are trading just 2bps apart at 9.09% and 9.11% levels respectively would make the market guess on the widening of the spreads between the two or even inversion of spreads if the government stops issuing the 7.16% 2023 bond.
The spread between the 8.83% 2023 bond and the 8.28% 2027 and the 7.16% 2023 bond could narrow as the market buys into the spreads at over 30bps levels. Going down the curve the market is likely to take down the yields on the 7.28% 2019 bond given that it is trading at higher yields than the 8.83% 2023 bond. Market would also look to bring down yields on the 8.12% 2020 bond to narrow the spread between the 8.83% 2023 bond.
The corporate bond yield curve is flat with two, three, five and ten year benchmark AAA bonds trading at levels of 8.70% to 8.80%. The market is likely to favor corporate bonds in the two to five year segment as spreads at levels of 100bps to 85bps are higher than spreads on the ten year bond at around 73bps levels.
The OIS (Overnight Index Swaps) yield curve is inverted with one and five year OIS yields trading at levels of 8.62% and 8.51% respectively. Given prospects of rate hikes, market may not look to flatten the curve before the hike but post hike (if any) the market would look to bring down one year OIS yields below five year OIS yields.
The system is borrowing around Rs 87,800 crores from the RBI. Bids for repo in the LAF (Liquidity Adjustment Facility) averaged Rs 41,000 crores on a daily basis last week. Term repo outstanding is Rs 39,000 crores (cut off was at 8.51% in the 11 day term repo auction). MSF borrowing was Rs 7,800 crores (as of 21st November 2013). Borrowing from the MSF could stop going forward given that bank deposits have been growing at 15.4% levels year on year as of November 2013 up from levels of 13% seen in August 2013.