Liquidity tightened considerably last week with the market borrowing from RBI crossing Rs 170,000 crores. Third quarter advance tax payments led to outflows from the system causing a liquidity drain. Liquidity as measured by bids for repo in the LAF (Liquidity Adjustment Facility) of the RBI averaged Rs 159,000 crores on a daily average basis against an average of Rs 97,000 crores seen in the week before last.
RBI signaled a shift in its stance from containing inflation expectations to supporting growth in its policy review last week. RBI will want liquidity conditions to remain easy for credit growth to pick up and it will have to undertake more OMOs (Open Market Operations) to infuse liquidity into the system. RBI has carried out three bond purchase auctions in December 2012 and has bought a total of Rs 31,000 crores of bonds through the auctions. The market will expect the RBI to purchase more bonds through OMOs.
Government bond yields will trend down in the coming weeks on the back of easing government bond supply, bond purchases by the RBI and rate cut expectations commencing January 2013. The government has Rs 72,000 crores more left to borrow in the next three months as it comes to the end of its borrowing program. Expectation of the government exceeding its budgeted borrowing is going down on the back of the government’s confidence of sticking to its borrowing schedule.
RBI bond purchases to ease liquidity will help reduce net supply of bonds from the government. The market will have confidence to build long positions in bonds on rate cut expectations without worrying about a supply deluge.
Ten year benchmark government bond yields closed almost flat last week with the 8.15% 2022 bond closing at 8.15% levels. The yield on the bond will trend down in the coming weeks on the back of the factors mentioned above.
Corporate bond yields will trend down in the coming weeks on the back of falling government bond yields. Five and ten year benchmark AAA corporate bond saw yields falling by 3bps week on week to close at levels of 8.93% and 8.95% respectively. Five and ten year AAA credit spreads fell by 3bps and 5bps week on week to close at levels of 65bps and 70bps respectively. Credit spreads will trend up as government bond yields fall faster than corporate bond yields.
The OIS market saw the yield curve move up week on week on the back of RBI maintaining status quo on policy rates in its December policy review and on the back of tight liquidity conditions. OIS yields are likely to stay flat in the coming weeks on tight liquidity conditions.
Governmentbondauction
The government auctioned Rs 12,000 crores of bonds last week. The bonds auctioned were the 8.07% 2017 bond for Rs 3000 crores, the 8.15% 2022 bond for Rs 6000 crores and the 8.97% 2030 bond for Rs 3000 crores. The cut offs came in at 8.12%, 8.15% and 8.34% respectively. The government is scheduled to hold an Rs 12,000 crore auction this week.