The Hindu Business Line : Bond traders expect yields to move up

Bankers said the major worry in the markets was the impact of high oil prices. Oil prices continued to remain upwards of $66 a barrel or about $495 a tonne.

Traders saythis could have a severe impact on the balance of payments with a consequent impact on both exchange rates and domestic yields. Imports of crude are in the region of about 2 million barrels a day.

In addition to oil companies, several foreign institutional investors hit stop losses in the equity markets. This was reflected in the spot exchange quotes moving down sharply to Rs 43.98 from Rs 43.70. With oil companies in the markets, there was a severe shortage of cash dollars.

Coupled with the 30 per cent per year-on-year credit growth and the market stabilisation schemes (MSS), this situation was leading to a tightening of liquidity. The amount mopped up through the reverse repo auctions of the Reserve Bank of India, fell sharply to Rs 9,725 crore last weekend against Rs 31,000 crore the previous week.

This tightening began early during the week after the announcement of the government's auction calendar.

Govt borrowings: The amount targeted through government borrowings is estimated at Rs 58,000 crore, slightly below market expectations. Yet, despite the lower borrowing schedule announcement, yields on both the 91-day and the 182-Treasury bill auctions hardened.

The cut-off yield on the 91-day T-bill was 5.20 per cent last week, though the weighted average yield was 5.16 per cent against 5.11 per cent the previous week.

The 182-day T-bill yield was 5.40 per cent against 5.36 per cent at the previous auctions. Against the notified amount of Rs 1,500 crore for the 182-day T-bill, inclusive of the MSS, the amount raised was only Rs 923 crore.

Yet, if this was a signal for a hardening of yields, it failed to reflect in the 10-year yield to maturity (YTM). The 10-year YTM on a weighted average basis ended the week at 7.09 per cent against the previous week's 7.10 per cent.

The outlook was not positive despite this marginal softening of the 10-year yields.

One of the evidence of this expectation was that not many traders see any increase in the notified amount for soaking up excess liquidity.

Low volumes: But, market trade volumes have clearly ceased to be a barometer for this sentiment. This was because trading volumes were low, completely contrary to international trends.

Trading volumes were barely Rs 2,000 crore during the week.

That the outlook was not very positive for yields was also apparent from the widening spreads. The spread between one year and 23 years is 176 basis points last week, up from previous week's 172 basis points.

The wide spreads, traders said, was partly driven by the absence of insurance companies in the bond markets. Insurers prefer to enter when long-term yields are high. But some of the life insurers have actually booked profits in the equity markets which though have not yet gone into the G-Secs.

"It's a waiting game, since yields are expected to move up," one trader said.

These trends, however, were expected to lead to some difficulties for the State loan auctions. States are expected to raise at least Rs 840 crore. Bankers said that given the trends in the markets, the States would be expected to shell out at least 7.8 per cent for their 10-year loans. Buying interest for State government securities would be only from life insurance companies and only if the yields were attractive.

For the yields to be attractive, it should have be at least 50-75 basis points above sovereign yields.

Global trends: Anticipation of hardening yields was also driven by international trends.

The Federal Reserve Board pushed up the Fed Funds rate to 3.75 per cent and the Federal discount rate to 4.75 per cent respectively.

Besides, FIIs are exiting from some of the Indian equities and reallocating their baskets. In fact, with yields improving in their home turf, many of them have moved back to the US.

More outflows: Along with the oil companies sourcing foreign currency funds, markets are beginning to see more outflows than inflows. For the latest reporting week, foreign exchange reserves fell by over $1.055 billion, resulting in a hardening of short-term forward premia. One-month forward premia, for instance, is about 1.25 per cent. Long term forward premia, six months to a year, was below one per cent, implying that inflows were expected during this period.

Moreover, with inflation at 3.53 per cent, one year real yield was down to slightly above 2 per cent. Nominal yields are expected to tighten, not just due to rising demand for foreign currency for oil purchases, but also because of the continuing high credit growth.

Steps up recovery: Banks have also stepped up recovery efforts and were expected to bring down their gross non-performing assets to less than three per cent with recoveries targeted at Rs 500 crore to Rs 1,000 crore.

As a result, despite the high accretions of risk weighted assets, banks capital adequacy has remained steady at close to 12 per cent.

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