The Hindu Business Line : Bonds down on profit-taking, purchases by banks, insurers

Traders said that oil companies were active in the foreign exchange markets for their import payments. Most of the companies were also taking forward cover, bankers said. Oil prices are currently at about $63 a barrel. As a result, many of the refiners were locking into forward cover in the foreign exchange market and simultaneously hedging against future oil price increases. The anticipation was some hardening of crude purchases with the West Asian situation remaining volatile.

Tightening of liquidity

The drawdown in credit lines by oil companies resulted in tightening of liquidity. This was reflected in the weekend Liquidity Adjustment Facility auctions where the mop-up through reverse repurchases was just Rs 22,895 crore, almost half of what was siphoned off the previous weekend. This tightening also was reflected in the Treasury Bill auctions during the week. The yield on the 91-day Bill firmed to 6.48 per cent, up from the previous week's 6.44 per cent. The weighted average yields also hardened to 6.44 per cent.

The hardening also was reflected in the 10-year yield to maturity (YTM) rising by 11 basis points to 7.85 per cent on a weighted average basis.

Bankers said that life insurers and banks were buyers during the first half of last week. In fact, large purchases by these institutions ensured that the average daily trade volumes remained well above Rs 2,500 crore during the week. Traders said that the purchases were done mainly as some insurers sold some of their equity holdings towards the end of the week and substituted them with fixed rate securities, in particular government securities. Many of the banks have also been liquidating their other investments and replacing them with government securities. Bankers demand for G-Securities was also driven by capital concerns. Bankers are currently expected to maintain the SLR even on their tier-II capital, since they are also treated as outside liabilities.

Confusing trends

But trends in the bonds remained confusing. The bid - offer spreads remained narrow. It was 5 basis points for short dated securities and 10 basis points for long dated securities. However, the yield spread between one year and 29 years widened to 160 basis points. A widening yield spread implied high demand for short-dated securities. Bankers said that this was precisely what was happening. In fact, purchases by the banking sector continued to remain at two years and below, for liquidity purposes. Clearly the anticipation was that yields could harden in the coming weeks. This was evident from the uptick in real yields. Though inflation was 4.78 per cent, real yields widened to 2.15 per cent. Bankers said the current regime of soft yields was seen more as a temporary phenomenon. These include external factors. The critical element was the Federal Reserve Board's meeting on September 20. The anticipation was another 25 basis point hike in the Federal Funds rate.

This anticipation resulted in slight widening of forward premia. One of the major factors pointing towards firm yields was the continuing credit expansion. Credit, driven by rural assets, continued to remain at a annual clip of above 30 per cent for most banks. As a result, the incremental credit-deposit ratio went over 100 per cent.

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