The Hindu Business Line : Insurers keen on high coupons only

BONDS remained flat last week in the absence of support from insurance companies and mounting concerns over the inflationary impact of high international oil prices.

Traders said the hikes in the US Fed rate and the Federal Funds rates had little impact on the domestic markets, because most of them had already discounted the hike.

Last Tuesday, the US Federal Reserve Board hiked the Fed rate or the Federal discount rate to 5 per cent and the Federal Funds rate to 4 per cent.

Bankers said that despite the short trading week, due to a series of festive holidays, oil companies were active sourcing dollars for meeting the payments for crude and product imports. Almost all of them were only in the spot market, since they had left their positions unhedged, anticipating the rupee to remain firm against the dollar. This was also true for some of the external commercial borrowers. In addition, foreign institutional investors were also sourcing foreign currency as they exited to meet the redemption of their participatory note holders, in particular foreign insurance, pension and university funds.

Liquidity tightening: The surge in foreign currency demand resulted in a tightening of liquidity.

Hence, the mop-up amount through the weekend three-day reverse repo operations contracted to Rs 6,785 crore against the previous weekend's Rs 20,840 crore.

The tightening also reflected in the weekly Treasury bill auctions. The cut-off yield on the 91-day T-bill hardened to 5.70 per cent, a two year high, against 5.57 per cent the previous week.

Similarly, the 182-day T-bill also hardened to 5.80 per cent, just two basis points short of the one-year yield of 5.82 per cent.

Spreads thin out: Moreover, the spreads between the two T-bills have thinned out, implying the preference for short tenure securities.

But for some of the more market-savvy traders, firm yields created an arbitrage opportunity.

They capitalised on the differential yields between treasury bills and funds raised through the collateralised borrowing and lending obligations (CBLO), earning spreads by as much as 25-30 basis points. This opportunity, traders said, was unlikely to be sustained with the hardening yields.

Yields harden: The hardening yields were evident from the 10-year yield to maturity (YTM). The 10-year YTM on a weighted average basis remained at 7.15 basis points last week, unchanged from the previous week.

The higher weighted average yield was despite the benchmark 7.38 per cent 2015 softening to as low as 7.05 per cent during the week. The large deviation between the weighted and the benchmark yield was due to banks' largescale sales of two other securities with an identical maturity.

These included the 9.85 per cent 2015 and the 11.43 per cent 2015. The turnover in both these securities was 10 times more than that of the benchmark at YTMs as high as 7.20 per cent.

Weak undertone: The weak undertone was evident from the low trading volumes of Rs 2,000 crore, partly due to sellers outnumbering buyers.

In fact, life insurance companies were making only limited purchases of high-coupon securities and only if the yields conformed to expectations.

There was little interest for low-coupon securities since the YTMs were short of expectations. Most insurers now prefer to wait for some more time anticipating a mid term hike in the repo and the bank rates.

The weak outlook was also evident from the high spreads between one and 23 years, which was about 172 basis points.

High credit growth: Bankers said that a major factor driving sentiment was the high credit growth. With credit continuing at a 30 per cent annual clip, most preferred alternative routes toraising deposits. These included the CBLO market, which is essentially an off balance sheet method of raising working funds.

Bankers said that it was this trend that helped bankers to ensure that lending rates remain low.

Moreover, with inflation at 4.5 per cent, the real yield rose to 1.2 per cent, up from the previous week's one per cent. Yet, despite this real yield increase, traders expect a further hardening, on account of the peak season credit offtake.

Credit-deposit ratios of most banks are at record highs of 67 per cent and incremental CD ratios of over 100 per cent.

As a result, incremental investment-deposit (ID) ratios have become negative, implying that bankers were actually selling securities.

Nominal ID ratios, as a result, have dropped below 40 per cent for the first time in two years as a result of continuous liquidation of securities for funding credit demand.

Govt borrowings: This trend was likely to create difficulties for upcoming government borrowing programmes. Government borrowings this month are estimated at Rs 13,000 crore, mostly in the form of securities with tenors above 10 years.

Two auctions are slated on Tuesday for the reissue of the 7.49 per cent 2017 and the 7.40 per cent 2035.

On the basis of current trends, bankers said that insurers had the appetite to pick up both these long-termers if the yields were attractive.

This implied that insurers would be at looking for yields upwards of 7.2 per cent for the 12-year paper and close to 7.75 per cent for the 30-year paper.

However, what could also determine the yields for the coming weeks would be foreign exchange flows. So far, there have been large outflows on account of oil payments and FII selling.

But this has begun to reverse and inflows picked up during the last week after rupee's continuous slide. The reversal was mostly on account of exporters beginning to remit their earnings to take advantage of the exchange rate and rollover of some of the forward contracts.

As a result, inflows during last week were $678 million, taking the foreign exchange reserves to $143.774 billion. Forward premia also remained low at less than one per cent.

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