The Hindu Business Line : Forward premia drops on Fed move to check sub-prime crisis

The brake in the free fall came after the Federal Reserve made a surprise 50 basis point reduction in the US discount rate to 5.75 per cent. The move was made to ease the shortage of dollar liquidity in the US markets. The move, bankers said, was intended to convey that the Fed would provide liquidity support to depository institutions and banks.

Curiously the Fed move comes close on the heels of the Bank of China’s statements to liquidate US treasuries. China holds in excess of $400 billion of US treasuries. Most of the holdings are medium and long-term securities.

The Fed move pushed the one-month and 3-month forward premia down to the sub one per cent level, a level that had prevailed four weeks ago. But 6 and 12 monthsremained above one per cent. Despite the drop in forward premia, bankers said oil companies did not take advantage of the situation. This was despite the fact, that oil prices remained above $72 a barrel and were forecast to rise further, in line with the dollar’s depreciation.

But the drop in premia signalled capital inflows were likely to pick up. In fact, even during the worst of the FII selling, capital inflows was little effected. FIIs’ sale of equities between August 13 and August 17 was Rs 13,241 crore. But banking flows, implying inward remittances from non-resident Indians, neutralised the FII impact considerably.

This was also one of the reasons for forward premia softening.

The large inflow was evident from the weekend liquidity adjustment facility (LAF) auctions. At the LAF auctions, there were 25 bids for Rs 30,650 crore, all for reverse repos. This was despite the mop-up of Rs 4,000 crore through issue of the 5.48 per cent 2009 market stabilisation security. The security was placed at 7.99 per cent.

However, at the Treasury Bill auction, the bid amounts revealed signs of tightening markets. Bid amounts shrank and cut-off yields firmed. The cut-off yields at the 91 day T-Bill auction was 6.73 per cent, up from the previous week’s 6.56 per cent. Similarly, the weighted average yields firmed to 6.65 per cent up from 6.48 per cent. The bids, both competitive and non competitive, were Rs 3,753 crore. The cut-off yield at the 364 day T-bill auction firmed to 7.49 per cent.

The 10-year yield to maturity (YTM) closed at 8.02 per cent on a weighted average basis, towards the weekend, up from the previous weekend’s 7.98 per cent. In fact, during the week, the 10 -year YTM had touched a high as 8.05 per cent.

The undertone was weak. Daily trade volume was down to Rs 5,400 crore last weekend. Besides, the bid offer spreads were close to 20 basis points, indicating low trading interest in view of the uncertain situation.

Outlook bearish

Bankers said that the outlook remained bearish. This was evident from the shrinking yield spreads. The spread between one year and 29 years was below 100 basis points for the first time in two months. There were other signs as well. Put-call ratio remained close to 1.3, implying that more FIIs were on the verge of cashing out of the equity markets. The rumbles are likely to be felt in the coming weeks, bankers said.

This was despite the fact that the one-year real yield was over 3 per cent based on the latest WPI-based inflation of 4.05 per cent.

Inflation, however, was little consolation. This was in view of the expectation of turbulence in the equity markets, that would spill over into the debt and exchange markets. But bankers said flexibility to intervene was very limited. This was because any sharp deprecation in the rupee would have inflation galloping, particularly with weighted average oil import prices currently at about $68 a barrel.

Besides, peak season credit off take was likely to be buoyant. This was largely on account of the bountiful monsoons. Anticipating the increase, banks have stacked liquidity. This was evident from the incremental cash-deposit ratio of 69 per cent as against the prescribed cash reserve ratio of 7 per cent. Banks have been feverishly raising resources and deposit growth has accelerated to about 26 per cent. Barring a handful of banks, most of them have baulked at cutting back rates fearing it would impact resource mop-up. Incremental investment ratio was down to 28 per cent and was moving closer to the prescribed statutory liquidity ratio of 25 per cent, as banks cash out. Consequently, few bankers expected knee-jerk reactions from the banking regulator. Changes, if any, they said were unlikely before the credit policy in October this year.

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