The Hindu Business Line : Bond traders wait for monetary policy review for direction

For most traders, the bond market is dead, at least, for now. Only after the review on January 24, they are expected to sing in unison "Long live the bond market." But they may not if the current disquiet in the markets remained. Depressed trading interest was evident from the thin volumes and large buy-sell spreads. Bankers said that this was driven by fears that the liquidity was expected to tighten.

Besides, there was anxiety over the current standoff in the Gulf and oil prices shooting up to $67 a barrel. Fears were that if Iran halts oil exports, prices could barrel up more than $70.

Traders said that none of the oil companies were taking chances and have already begun taking forward cover. Some companies have also stepped up their imports for stockpiling in the event of an escalation in the Iran-US confrontation.

Domestic liquidity: The repercussions of these events and rising credit demand were felt on domestic liquidity. At the T-bill auctions last week, the cut-off yield on the 91-day T-bill remained at 6.19 per cent, the same level as the previous week and close to the repo rate of 6.25 per cent. But, the difference between the cut-off and weighted average spreads narrowed. The weighted average was just four basis points below the cut-off.

The 364-day T-bill yield though was already above the repo rate at 6.30 per cent.

Tapping repo window: The tightness in liquidity was also evident from the three-day repo/ reverse repo auction trends. More banks began taking resort to the RBI's repo window last week. At least Rs 14,250 crore was drawn from the RBI's repo window.

Bankers said that these trends pointed to only one direction - that is repo and bank rates were likely to move up by at least25 basis points during the third quarter review.

The 10-year yield to maturity (YTM) though remained stable but weak. The 10-year YTM on a weighted average basis was 7.2 per cent, up slightly from the previous week's 7.19 per cent.

Trade volumes: The dull sentiment was evident from the trade volumes that were less than Rs 1,000 crore. In fact, during the last week, most banks were sellers. This time though they were selling mostly near-term securities. Bankers said that some losses were incurred in the trade, since some of them had picked up the securities at high prices and sold at lower rates. The buyers were mostly mutual funds, traders said.

Bankers said that the losses incurred in selling the securities were however notional, since the funds realised were deployed in credit where returns were far higher.

In fact, the flavour of the season was farm and SME credit. The reason for this was that in both these sectors the yields are as high as 9 per cent. Consequently, even if the advances are small in value and administrative costs are higher, the spreads are at least 3 per cent over the weighted average cost of working funds, bankers said.

So, losses incurred in selling near-term investments, particularly treasury bills, were largely notional, bankers said.

Moreover, in farm and SME credits, banks are entitled for refinance support from lending institutions such as Nabard and SIDBI. Tapping such refinance windows gives banks a spread of at least 2 per cent.

Bankers are already beginning to take advantage of all such refinance windows in the coming weeks as well. Some bankers were also resorting to arbitraging between call and the repo window of the RBI to earn a spread of anywhere between 50 basis points and 75 basis points.

State Govt loans: Yet, despite the tight liquidity situation, two State Government loans of Haryana and Andhra Pradesh were placed successfully at 7.33 per cent.

This was because of the intervention of Life Insurance Corporation at an YTM of just above 24 basis points above the weighted average 10-year YTM.

Moreover, traders said, insurance companies are also offering some CBLO deals with banks to improve mean yield on investments.

Long-term yields: Since the CBLO deals were mostly on the long-tenor securities, yields for long-term securities dropped marginally.

Some traders said that another major factor for the tight liquidity was also on account of the IPO rush. Once these funds flow into the banking system, bankers said yields were likely to stabilise though unlikely to retreat. Traders said that yields were likely to remain range-bound.

The reason being the high credit demand and foreign exchange needs of oil companies.

In fact, substantial component of the credit demand during the last few weeks was driven by oil companies for meeting import payments. Oil companies have also begun taking forward cover, driving up premia for three months above 3 per cent, the highest level in three years. Besides, bankers said exporters were also holding back some of their inward remittances anticipating a further hardening of forward premia in line with firming oil prices.