The Hindu Business Line : Life insurers, MFs keep bonds firm

Insurers replaced some of their low coupon securities with high coupons, since most of them were available at high yields, traders said. The buying was largely in the form of switches, they said. Besides, there were also considerable purchases by some of the unit-linked insurance companies in the markets, especially for the balanced fund insurance plans.

This trend allowed traders to ignore the advancing oil prices. In fact, some of the oil companies have preferred to wait anticipating a retreat, once the US begin releasing oil from its strategic reserves. Oil prices are currently within striking range of $50 a barrel as a result of supply cut backs due to the continuing sabotage of pipelines in Iraq.

Liquidity was beginning to tighten in the markets. This was evident from the rise in the yield on the 91-day T-bill auction last week, where the cut-off yield was fixed at 4.91 per cent. In fact, unlike the previous week, where several bids were rejected in view of the high yield, the RBI chose to accept the bids even at high yields.

Last week, the RBI accepted all the bids for Rs 2,000 crore, which fell within the cut-off yield range. This was unlike the previous week, where bids for only Rs 705 crore were accepted, since most of them were priced at high yields, way above the cut-off level of 4.75 per cent.

This high T-bill setting has now once again triggered speculation that some tightening measures are under way with a possible hike in the repo rates from the current level of 4.5 per cent. This anticipation is also driven by the fact that the US Fed has hiked its repo rateto 1.75 per cent.

However, these anticipations notwithstanding, the ten-year yield to maturity (YTM) on a weighted average basis marginally retreated to 6.09 per cent last week as against the previous week's 6.12 per cent.

The undertone in the markets remained steady. There was slight rise in trading volumes to about Rs 5,400 crore towards the weekend. Further, the spread between one year and 24 years was down to 141 basis points, indicating a flattening yield curve, down from previous week's 152 basis points.

The flattening was partly because of the switches. Life insurers purchased long-dated securities at low prices and banks/ funds were into the short end of the yield curve at high prices. Traders said that these switches plus the bailout by the RBI two weeks ago had considerably reduced the depreciation provision for the banks.

Most banks intended to remain at the short to the medium end of the yield curve for liquidity preference purposes.

Insurers have struck good bargains picking securities such as the 12.32 per cent 2012 and the 11.83 per cent 2014.

Bonds are likely to be steady. This is on account of the fact that negative real yields are of little consequence to bulk buyers. Despite inflation reversing last week's trend, real yields up 30 years continued to remain below the inflation rate.

But traders said that more banks were expected to begin liquidating their holding of G-Secs with the slight yield correction to book profits. Most them currently have an investment-deposit ratio in excess of 45 per cent, as against the stipulated statutory liquidity ratio of 25 per cent.

Further, traders said that oil-driven demand for foreign exchange was likely to drop by next week, once oil prices begin falling in line with US Government release from its strategic reserves.

In fact, a fall in oil prices and firm rupee is what oil companies prefer. With this expectation on the verge of becoming a reality, oil companies were expected to make their moves. Already, some have taken forward covers at the current low levels to lock into the current level of exchange rates, traders said. This was one of the major factors driving up short-term forward premia to above 2 per cent, particularly for one to three months.

On the other hand, long forward premiums have remained under 2 per cent. This trend was partly due to the large increase expected in non-debt related inflows, traders said.

Export earnings are expected to top $75 billion this year. Besides, FDI flows are also likely to gain pace. For the latest reporting week, despite the large-scale intervention by the RBI, foreign exchange accretion remained $104 million. Currently, forex inflows were in the region of just about $75-100 million per day.

But these flows were unlikely to influence the reversal of a hardening yield, traders said. This was on account of the high oil prices and the impact of this on the current account deficit. Oil prices have also somewhat helped the RBI to cut costs of intervention in the markets, through sterilisation.

The slowdown in reserve money accretions, the burgeoning credit demand and the possible bunching of Government borrowings were expected to keep interest rates on the ascent in the markets, traders said. In fact, corporates have begun borrowings ahead of the peak season. Most of them have liquidated their investments held as part of their working capital management. The rise in demand has pushed up their spreads to over 200 basis points over sovereigns.

These high spreads notwithstanding, corporate borrowing costs were still way below the prime lending rates (PLR). The only difference is that the discounts to PLR have narrowed substantially to about 250 basis points.