The bond market is staring at heavy supply of money market securities and bonds after the RBI unveiled fresh measures to curb INR volatility. The Central Bank has announced that it will auction Rs 22,000 crores of Cash Management Bills (CMB) every Monday staring 12th August 2013. The CMB auction will suck out liquidity from the system and take up overnight money market rates to levels of 10.25% and higher.
RBI will auction Rs 11,000 crores of 35 day CMB on the 12th of August and Rs 11,000 crores of 34 day CMB on the 13th of August. Over and above the CMB auctions there are State Development Loans (SDL) auctions, Treasury Bills (T-Bills) auctions and Government Bond auctions scheduled for this week. RBI will auction Rs 7300 crores of SDL on the 13th of August, Rs 12,000 crores of T-Bills on the 14th of August and Rs 16,000 crores of government bonds on the 16th of August. Total supply of money market securities and bonds for this week is Rs 57,300 crores.
The bond market will push up yields across the curve, as there is not enough liquidity in the system to absorb the supply. RBI has restricted banks and primary dealers access to the LAF (Liquidity Adjustment Facility) to a total of around Rs 37,000 crores. Banks will have to borrow from the RBI at the MSF (Marginal Standing Facility) rate of 10.25%. Hence yields at the short end of the yield curve will rise to over 11% levels and will trade at those levels for a period of time.
The medium to long end of the yield curve too will move higher as the market perceives that the RBI will not let up on monetary tightening until the INR stabilizes at higher levels to the USD. The INR touched all time lows of Rs 61.80 to the USD last week and closed at record low levels of Rs 61.30 on the 7th of August. RBI sold USD in the market to prevent further fall in the INR. The central bank does not have an endless supply of USD to sell and hence it is strangling liquidity to prevent INR volatility.
The ten year benchmark government bond, the 7.16% 2023 bond saw yields fall by 13bps week on week to close last week at levels of 8.16%. Bond yields fell on the back of markets believing that the RBI will not take any steps to prevent INR fall as the government had announced the appoint of Dr. Raghuram Rajan as the new RBI governor to replace Dr. D. Subbarao whose term ends next month.
The rude shock of heavy supply will take up the ten year yield to 8.50% levels, where it will stabilize, as the market will buy into the bond at higher levels of yields.
Corporate bond yields came off last week with five and ten year benchmark AAA corporate bond yields falling by 10bps and 5bps respectively. Five and ten year AAA credit spreads closed mixed with five year credit spreads falling by 2bps and ten year credit spreads rising by 11bps to close at levels of 62bps and 103bps respectively. Credit spreads are likely to fall as government bond yields rise faster than corporate bond yields on the back of heavy supply.
OIS (Overnight Index Swap) yield curve fell last week with one and five year OIS yields falling by 13bps and 5bps respectively. The OIS yield curve will invert further from current levels of 87bps as RBI strangles liquidity leading to sharp rise in MIBOR rates.
Liquidity as measured by bids for the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids for repo averaging Rs 37,000 crores on a daily basis last week against an average of Rs 37,400 crores seen in the week previous to last. The MSF outstanding rose from levels of Rs 2200 crores to levels of Rs 23,930 crores (as of 7th August 2013) week on week. Bids for repo will stay around Rs 37,000 crores levels given RBI’s restriction on banks access to the repo window for funds while MSF outstanding will trend higher on heavy demand for funds to absorb the supply of securities by the RBI.