Bond markets had the strongest bout of volatility in over four and half years last week. The surprise move by RBI to tighten liquidity through restricting LAF (Liquidity Adjustment Facility) lending to Rs 75,000 crores, raising MSF (Marginal Standing Facility) rate to 300bps (from 100bps) over the repo rate and conducting OMO (Open Market Operation) sale auctions took up money market security yields, government bond yields, corporate bond yields and interest rate swap yields sharply higher. Yields rose by 50bps to 150bps across yield curves post the RBI actions to control INR volatility.
The ten year benchmark government bond the 7.16% 2023 bond saw yields rise by 60bps from pre action levels of 7.56% to post action levels of 8.16% before coming off to close the week at levels of 7.94%. Bond market volumes fell by 50% as market participants refrained from trading at higher levels of yields. Bond yields hit upper circuit limits leading to the market being frozen at points of time before limits were eased to facilitate trading.
Government bond yields eased from highs as the RBI indicated that it was not comfortable with yields trending up. The central bank first rejected all bids in the Rs 12,000 treasury bill auction and then rejected 79% of the bids in the Rs 12,000 OMO sale auction held last week. RBI also devolved 23% of the Rs 15,000 crores government bond auction on to the PDs (Primary Dealers).
Bond markets took the cue from the RBI and stared covering short positions at higher levels of yields leading to bond yields coming off by 20bps to 30bps from highs seen during the week.
The bond market will be nervous on worries of more OMO sale announcements and on auction devolvement on PDs and yields are likely to trend higher from current levels. The market will also worry about monetary tightening actions by the RBI in its 30th July 2013 policy review. Market will want bond yields at higher levels as it goes into the policy to avoid any surprise in the policy.
The RBI is unlikely to tighten policy rates on the 30th of July as it has seen the negative effects of its liquidity tightening measures. The measures have not really held the INR much as the currency has just strengthened by less than one percent post the RBI action. Bond yields will then trend down from higher levels as the RBI refrains from raising rates.
Money market securities saw a sharp rise in yields on worries of high overnight money market rates. Treasury bill yields rose across the curve by 90bps to 100bps while CD (Certificate of Deposit) yields rose by 125bps to 150bps across the curve. Money market yields will stay at higher levels until RBI eases liquidity in the system.
Corporate bond yields rose by 70bps to 90bps across the curve last week. Five and ten year AAA benchmark credit spreads rose 20bps and 27bps respectively to close last week at levels of 102bps and 135bps respectively. Credit spreads will stay at higher levels until volatility in government bonds subside.
OIS (Overnight Index Swap) markets saw five over one OIS spread invert by 53bps with one year OIS yields rising by 112bps and five year OIS yields rising by 50bps week on week to close at levels of 8.64% and 8.08% respectively. The curve will stay inverted until liquidity eases and overnight rates come off.
Liquidity tightened last week as banks hectically covered their product after the RBI moves to curb INR volatility. Liquidity as measured by bids for the LAF (Liquidity Adjustment Facility) auction of the RBI saw bids for repo averaging Rs 103,000 crores on a daily basis last week against an average of Rs 52,000 crores seen in the week previous to last. Banks are well covered on their product for the reporting week and liquidity is likely to ease this week as banks demand for funds will come off.