The Hindu Business Line : Bonds look to Credit Policy for direction

Hedge funds have encashed some of their equity holdings and begun moving back into commodities, in particular oil funds, according to traders. This in turn has pushed up bond yields. In addition, oil companies were also beginning to move into the markets to tie up for their oil purchases, before prices go up further.

Traders said that the FII selling was also prompted by anticipation of a further hardening of US interest rates.

US Fed rate: Traders are anticipating another 25 basis points hike in the US Fed Funds during the next meet. But, few expect any change in domestic interest rates at the Credit Policy announcement.

This was partly because yields on T-Bills remained well within the reverse repo (4.75 per cent) and the Bank Rate (6 per cent) band. The 91-day T-bill yield was 5.19 per cent, slightly up from the previous week's 5.15 per cent.

The yield on the 182-day T-bill was 5.29 per cent. In both these auctions, the issues were oversubscribed.

However, traders expect that the Market Stabilisation Scheme (MSS) issuances may be reduced. In fact, most traders felt that it was the MSS that was leading to liquidity pressure in the markets, driving out subscribers from dated securities into short-dated papers. As a result of the MSS, traders said, yields on dated securities were hardening.

As if to confirm this, the 10-year yield to maturity hardened to 7.14 per cent last week, up from the previous week's 7.08 per cent. The hardening was despite the fact that at the weekend reverse repo auction the mop-up amount was Rs 31,475 crore.

High liquidity: One of the major reasons for this trend of high liquidity in the repo auctions and hardening yields was the bankers' preference for liquidity.

Most bankers preferred to book small losses in selling some of their securities and park the resources in reverse repos. This allowed them to operate on high credit-deposit ratios.

Life insurers turn sellers: Besides, traders said that some life insurance companies were also active in the markets.

Life insurers were active sellers of government securities to support the equity markets from any sharp falls due to FII selling pressures, traders said.

The dampening of sentiments in the markets was evident from low trading volumes.

Average trading volumes barely exceeded Rs 2,000 crore during the week. Besides, the spreads between one year and 23 years also widened to over 190 basis points. This was because there was little interest, even from insurers, in long-dated securities.

As a result, the yield on the 29-year paper, 7.50 per cent 2034, jumped to 7.69 per cent. The poor interest reflected in the government's auctions of dated securities. The cut-off yields on the securities were fixed at 7.48 per cent for the 8.07 per cent 2017 paper and 7.94 per cent for the 7.5 per cent 2034 paper.

Weak outlook: Traders said that the outlook was also likely to remain lacklustre in the coming weeks, overshadowed by FII selling pressure. Selling by FIIs in the markets, however, did not push up forward premia.

In fact, forward premia dropped last week, though the one to 12 month curve continued to remain inverted, with one month at 2.22 per cent, six months at 1.81 per cent and 12 months at 1.49 per cent.

Traders said that this was partly because some exporters were beginning to remit their earnings back into the country.

As a result, traders said, the outflows from non-debt capital was somewhat negated by current account flows. Besides, there were also large accretions from non-resident depositors into banks. These, bankers said, were not speculative in nature, and some of the existing dollar depositors were converting them into non-repatriable Indian rupees or shifting to domestic mutual funds.

Forex accretions: For the latest reporting week, the accretions were $88 million. Bankers said, although there was no major liquidity pressure on the banks, most of them preferred to reduce their holdings in government securities.

Part of the reason was that most felt that their holdings were in excess of statutory requirements.

Therefore, they were in a position to dilute their holdings to match their demand and time liabilities.

Bankers were holding only short-dated securities in their mark-to-market categories (held for trading and available for sale).

With credit demand continuing unabated, bankers' focus was on meeting this demand. The reason was particularly because the spreads in credit were far more attractive than that from investments in government securities.

Credit offered spreads of close to 5 per cent over the weighted average cost of working funds and the lending risks were also considerably less than in the past.

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