The Hindu Business Line : Bonds go into a tailspin

Traders said what also hit them were the removal of interest on cash reserve ratio (CRR) balances. So far, bankers were receiving interest at the rate of 3.5 per cent on the incremental CRR balances of 2 per cent. The RBI has withdrawn that interest payments without any reduction in the CRR. Most traders took this as a signal from the RBI of a further rise in rest rates and tightening of liquidity as part of inflation control strategies. Inflation had risen to 5.24 per cent after the recent hike in petroleum prices.

The auctions last week for Rs 9,000 crore through the issuance of eight year (7.37 per cent 2014) and 15 year (7.94 per cent 2021) papers also led to tightening of liquidity. Both these papers were placed at high YTMs (yield to maturity) of 7.92 and 8.46 per cent respectively.

The weekly treasury bill auctions also indicated that much. The cut-off yield on the 91-day treasury bill rose to 6.31 per cent last week from 6.19 per cent the previous week. Similarly, the 364-day T-bill yield hardened to 7.05 per cent, above the repo rate of 6.75 per cent. Besides the spreads between the two also widened to 75 basis points, clearly indicative of the bias in favour of short-term securities.

As a result the mop-up through the three-day weekend liquidity adjustment facility auctions shrank to about Rs 30,000 crore. However, traders said the signals also conveyed that no changes in MSS amounts were expected. In fact, the expectations clearly pointed to another hike in the repo and reverse repo rates ahead of the Credit Policy review.

With the liquidity squeeze measures in full swing, the ten-year YTM hardened to 8.18 per cent on a weighted average basis last week. The previous week, the ten-year YTM was 7.83 per cent.

Respite likely

Taking a cue from the RBI's signals, daily trade volumes remained low. Insurers also stayed away as they continued to prop up the equity markets. Few insurers were buyers, though most of them preferred to remain at the short end of the yield spectrum as a precautionary measure.

But traders said that bonds are likely to take a respite in the coming weeks ahead of the finalisation of the first quarter results. This was evident from the slight reduction in the yield spreads between one and 29 years. This spread was under 160 basis points. Besides, despite the rise in inflation to 5.24 per cent, real yields were down 1.81 per cent last week. This is first time since the beginning of this fiscal that one-year real yields are falling below 2 per cent.

Other signals

There are other signals as well that yields could be stabilising at the current levels. Forward premia were down sharply , despite oil companies remaining active buyers for meeting import payments. Traders said that soft premia was largely on account of anticipated inflows. Inflows expected were largely from current account and non-debt capital account over the next few months. These inflows also included foreign currency convertible bond issues by domestic corporates.

Such flows are also expected to be supported by institutional and hedge fund purchases. This was evident from movements in a key indicator - put-call ratio in index futures. High put-call ratios indicate that there are more exits and low ratios indicate the exact reverse. Consequently as this ratio comes close to one, it implied inflows. On Friday last, this ratio for index options was below one at 0.8. This ratio had peaked at 1.4 during the FII exits that brought the BSE sensitive index to below 9000, during the early part of this month.

Such inflows are likely to augment accretions to foreign exchange reserves, though unlikely to translate into greater investments into US dollar securities, given the possibility of further hikes by the Federal Reserve Board.

Shift to investments

Moreover, bankers said, with credit slowing down, there was a marked shift to investments. Investment deposit ratios are on the ascent. ID ratios, which had dropped to as low as 33 per cent are now close to 35 per cent. With credit tightening, bankers now appear to returning to investments, at least during the slack season.