The Hindu Business Line : Life insurers' interest keeps bonds firm

BONDS remained steady last week supported by weakening oil prices in the global market and interventions by the Reserve Bank of India through repurchase operations (repos).

Traders said that support came from life insurance companies and other financial intermediaries including mutual funds.

The weakening trend in the bond market got reversed, particularly after the hike in the US Federal Funds rate to 2 per cent.

RBI support: Traders said that the RBI's support to money market operators in the form of repos resulted in injecting at least Rs 7,500 crore. Repos are purchases of securities by the RBI from banks and financial institution for a predetermined period at the bank rate of 6 per cent. Traders said that several banks took advantage of the RBI's window in view of the long weekend.

This resort to the RBI window was also triggered by fears that the current bank rate may not last for long. Traders anticipate changes in view of the high cut-off yields fixed for the 91-day and the 364-day Treasury bill auctions. The 91-day T-bill was placed at a cut-off yield of 5.58 per cent last week. This was up from the previous week's 5.44 per cent.

The yield on the 364-day Treasury bill was 5.76 per cent, up from the previous auction level of 5.69 per cent.

Tight liquidity: The spreads between the 91-day and the 364-day T-bills were 19 basis points, indicating tight liquidity. Besides, at the dated securities auctions, the yield for the 7.55 per cent 2010 was fixed at 7.20 per cent.

For the 7.95 per cent 2010 paper, the yield was fixed at 8.24 per cent. Inclusive of the underwriting commissions, the effective yields were at least 0.05 basis points higher.

The tightness reflected in the ten-year yield to maturity (YTM) remaining at 7.19 per cent on a weighted average basis. Intra-week, the yields had hardened to as high as 7.34 per cent. These levels, however, triggered large-scale purchases by the insurers.

Insurers' interest: But life insurers interest was focussed on long-dated and high coupon securities. In fact, some of the banks that had shifted high coupons to the held-to-maturity (HTM) category to book current yields, brought them back to the `available-for-sale' and `held-for-trading' categories.

This resulted in securities such as the 10.71 per cent 2016 being back in action. Life insurers were interested in this security for their savings linked policies. The competitive interest in such securities resulted in pushing down yields at the long end.

Since life insurers' interest was only on high coupons, there were severe skews in the yield curve at the long end. For instance, traders said that even with yields on the 5.64 per cent 2019 at 7.51 per cent there were few takers.

On the other hand, the favoured security was the 10.03 per cent 2019 with insurers scrambling for it at YTMs as low as 7.22 per cent. Life insurers' interest in these high coupon securities was particularly on account of the high yields. The high current yields on these securities would also help them declare bonuses to their policyholders.

In particular, the private sector insurers were interested in the high coupons since few have managed to pay out bonuses on the same scale as Life Insurance Corporation.

Weak undertone: However, the undertone in the markets remained weak. This was apparent from the thin trading, with volumes barely touching Rs 2,000 crore.

Besides, outlook for the markets also remained weak, traders said. This was evident from the wide spreads between one year and 24 years. These spreads were 155 basis points, a sharp jump from last week's 117 basis points.

The rising yields also pushed up the real yields for maturities above 10 years. Inflation as measured by the wholesale price index was 7.06 per cent.

The rising real yields, however, clearly had other signals as well. Traders said that it was a pointer to a further hardening of the bond markets in the coming weeks.

Revenue shortfalls: One reason for this hardening was that more borrowings were likely in the coming weeks by the Government to offset the revenue shortfalls.

In fact, it was this fear of a fiscal slippage that prevented the cut back on Customs and Excise duties on crude oil to neutralise the impact of increases in international oil prices. While oil prices appeared to have retreated, oil futures continue to remain above $50 a barrel. This remains a cause of worry for oil traders, who are expecting another price spike.

Forwards march: As a result of the oil price spike expectation, forward premiums continued to move up. The premiums for up to six months were above 3 per cent. Traders said that one of the major factors keeping the pressure on forward premia was quality of inflows.

Although external reserves increased by about $1.046 billion to $122 billion for the last reporting week, traders said they were mostly in the volatile component - - external commercial borrowings and FII flows, both of which tend to drive up forward premia.

Some traders said that FIIs have already begun taking forward cover in view of the year-end. This implied that foreign currency demand was likely to worsen the liquidity pressures.

Moreover, credit demand also continued unabated. The credit-deposit ratio of the banking system was above 61 per cent last week, a clear pointer to the tightening liquidity.