Bond market sentiments are turning distinctly bearish on multiple worries of rising fiscal deficit, rupee depreciation and tight liquidity conditions. Yields on government bonds, corporate bonds and interest rate swaps moved higher week on week on the back of bearish sentiments. The markets will require a higher than expected rate cut from the RBI in December 2012 for sentiments to turn positive.
The government has unofficially indicated that fiscal deficit could be in the range of 5.5% to 5.6% of GDP for 2012-13. The new estimates are higher than the revised estimate of 5.3% of GDP that was put out in October 2012. The higher fiscal deficit could increase the government borrowing amount by Rs 50,000 crores. The market had factored in an Rs 20,000 crores extra borrowing for fiscal 2012-13 and if the extra borrowing amount is raised to Rs 50,000 crores, the market will find it difficult to digest the number.
The Indian Rupee (INR) closed last week at Rs 55.58 to the USD, the highest level in over two and half months. The INR is just around 2.7% off from its all time lows of Rs 57.20 seen in June 2012. RBI was seen selling USD at lower levels of the INR. A weak INR adds to inflation expectations as imports become costlier and it adds to liquidity tightness as RBI sells USD to stem the fall of the INR.
Liquidity as measured by the bids for repo in the LAF (Liquidity Adjustment Facility) auction of the RBI tightened last week. Bids for repo averaged Rs 113,000 crores on a daily basis last week against an average of Rs 108,000 crores seen in the week previous to last. The falling INR is hurting sentiments on liquidity on selling of USD by the RBI.
Bond market will look for rate cuts from the RBI in its December 2012 policy review. RBI board meeting minutes suggest that a majority of the board members favored a rate cut in October while the government is also hopeful of the central bank reducing rates on the back of lower inflation numbers for October 2012.
The ten year benchmark government bond, the 8.15% 2022 bond saw yields rising by 4bps week on week to close at 8.23% levels. The yield on the 8.15% 2022 bond is likely to trend higher to levels of 8.30% on worries of higher borrowing and tightening liquidity conditions. Markets will look to build long positions at 8.30% levels on expectations of rate cuts in December.
Corporate bond yields rose with five and ten year benchmark AAA bond yields rising by 5bps and 2bps respectively week on week. Corporate bond yields will be pressured on account of tight liquidity conditions.
OIS (Overnight Index Swaps) yields rose week on week on the back of liquidity worries. One and five year OIS yields rose 4bps and 7bps respectively week on week. The five over one OIS spread flattened by 3bps to close at a negative 56bps. Five year OIS yields are likely to rise further on the back of bearish bond market sentiments leading to the spread flattening further.
Governmentbondauction
The government auctioned Rs 13,000 crores of bonds last week. The bonds auctioned were the 8.19% 2020 bond for Rs 3000 crores, the 8.20% 2025 bond for Rs 7000 crores and the 8.83% 2041 bond for Rs 3000 crores. The cut offs came in at 8.24%, 8.34% and 8.50% levels respectively. The government is scheduled to auction Rs 13,000 crores of bonds this week.
State government auction of Rs 9140 crores of SDL (State Development Loans) saw cut offs on the ten year loans coming in a 8.85% to 8.89% range while cut off on five year loans came in at 8.68%.