The market outlook for the short end of the yield curve is distinctly better this month that what it was last month. Improved liquidity outlook coupled with the reduction in the MSF (Marginal Standing Facility) rate by 75 bps, has brought down yields at the short end of the curve by 75bps to 150bps on a month on month basis. RBI had lowered the MSF rate from 10.25% to 9.50% in its 20th September policy review.
Yields on 91 day and 364 day treasury bills have dropped by 130bps to 150bps while one year CD (Certificate of Deposits) yields have come off by 80bps. One year OIS (Overnight Index Swaps) yields are down by 90bps. Money markets are expecting the RBI to lower the MSF rate further from levels of 9.5% and are also expecting system liquidity to ease going forward.
RBI has scheduled an OMO (Open Market Operation) purchase auction for Rs 10,000 crores on the 7th of October 2013 and given that the auction stocks are in the two to twelve year maturity bucket, the market will comfortably tender stocks in the auction. OMO purchase auctions infuse liquidity into the system.
The central bank has indicated that the FCNR B swap window has already brought in USD 5.6 billion of flows into the system. The RBI is swapping USD at a fixed rate of 3.5% per annum with the banks and the swap releases INR liquidity into the system.
The busy season for the economy starts in October 2013. Demand for liquidity is high in the busy season as credit growth picks up on higher business activity post monsoons. The system also sees seepage of liquidity out of the system as notes in circulation increase on the back of rising cash demand for the festive season. RBI will have to make liquidity available to the banking system to meet the busy season requirements.
The INR too is helping improve outlook for liquidity. The currency has gained over 6% against the USD month on month and fears of capital outflows have receded on the back of positive FII flows of around USD 2 billion into equities for the month of September.
Government bond yields fell week on week on the back of the OMO auction scheduled by the RBI and on the back of expectations of the RBI lowering MSF rate. Ten year benchmark bond, the 7.16% 2023 bond saw yields fall 9bps week on week. The 7.28% 2019 bond saw yields fall by 28bps as the markets positioned for yield curve steepening. The longer end of the curve saw yields marginally down with yield on the newly issued 9.20% 2030 bond falling by 5bps.
The corporate bond yield curve steepened last week with one, two and three year benchmark AAA corporate bonds seeing yields fall by 10bps to 25bps while five and ten year bond yields fell by 5bps. Expectations of MSF rate cut and improved sentiment on the INR will further steepen the corporate bond yield curve.
OIS market saw one year OIS yield come off by 11bps and 5 year OIS yield fall by 19bps week on week as markets covered paid positions on the back of INR strength. The five over one OIS spread inverted by 8bps to close at a negative 44bps levels. OIS yield curve should see the five over one spread flattening on expectations of RBI lowering MSF rate.
Liquidity eased last week as banks released funds in the first week of the second half of the fiscal year. Borrowing under MSF (Marginal Standing Facility) fell by Rs 50,000 crores last week. MSF borrowing was Rs 32,000 crores as of 3rd October against levels of Rs 52,000 crores seen on the 27th of September. Repo borrowing was flat at around Rs 39,000 crores in the LAF (Liquidity Adjustment Facility) auctions of the RBI. Liquidity is likely to tighten this week on fresh demand for funds by banks in the first week of the reporting fortnight.