The Hindu Business Line : Inter-tenor spreads fall as selling wave continues in bonds

Financial Daily from THE HINDU group of publications Monday, Feb 06, 2006

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Money & Banking - Debt Market

Inter-tenor spreads fall as selling wave continues in bonds

C. Shivkumar

BONDS yields softened slightly last week on the back of a lower government borrowing projections and due to demand from insurance companies.

Bankers said the withdrawal of oil companies from the forex markets anticipating crude prices to weaken, also helped the bonds.

Oil prices dropped to $65 a barrel.

As a result, there was lower demand for liquidity during the week, evident from the week-end repo auction.

At the 3-day repo auction, banks drew barely Rs 5,000 crore, unlike the previous week when over Rs 20,000 crore was drawn.

Cut-off yields: At the 91-day T-bill auctions, the cut-off yields were 6.56 per cent, down from the previous week's 6.69 per cent.

The cut-off yield on the 364-day T-bills was down to 6.74 per cent.

Despite this drop, the yields remained above the repo rate of 6.50 per cent. Traders said that if the current trend continued, another round of reverse repo/ repo rates hike could not be ruled out.

The slight easing of liquidity conditions resulted in a softening of the 10-year yield to maturity (YTM), which eased to 7.16 per cent on a weighted average basis, down from 7.20 per cent the previous week.

Weak undertone: Despite the slight firming of bond prices, the undertone was weak, evident from low trading volumes.

Daily trade volumes remained under Rs 1,000 crore.

Banks, among the largest players in the bond markets, showed little interest.

Moreover, a new development appear to be taking place in the bond market.

The inter-tenor spreads were falling. Last week, the spread between one year and 28 years was less than 100 basis points.

The fall was led by a selling wave that continued to prevail in the markets.

This implied that the yield curve was becoming flat triggered by the rise in short-term interest rates.

Yields at the long ends, particularly for maturities above 10 years, dropped. This was because several insurance companies booked profits in the equity markets and moved back to bonds.

Though the volumes were low, in a thin market it still influenced yields.

Among the preferred securities were the 12.60 per cent 2018, the 10.45 per cent 2018, the 11.60 per cent 2020 and the 10.70 per cent 2020.

Bankers said the hardening of short-term yields was triggered by the high credit demand. Efforts to push deposit rates have still not translated into big inflows.

Deposit rates, especially term rates, are still below expectations.

The high short-term yields also resulted in pushing up the one-year real yield to 2.25 per cent.

In fact, the hike in rates and the actual accretion are likely to take at least a month to take effect.

Even the hike in rates, bankers said was more for short-term deposits, of less than a year where hikes were 50 basis points.

At the long end, deposit rates were more or less untouched, indicating that the demand was more for short-term liquidity.

Bankers said that part of the inflation in the credit-deposit ratio during the last few months was led entirely by oil companies.

Most of the oil companies are strapped for cash due to severe under recoveries in product prices and steep increase in crude import prices.

Govt borrowing: Bankers said that the tight conditions were likely to influence the government's planned borrowing of Rs 6,000 crore through reissue of the 7.46 per cent 2017 and the 7.4 per cent 2035 papers.

Expectations that the pricing for these papers are likely to be upwards of 7.4 per cent and 7.5 per cent respectively, based on the current level of pricing on both these papers.

Traders expect high underwriting fees in view of the tight liquidity situation and placement of these two papers may not be smooth.

Oil companies continued to influence the foreign exchange markets, ensuring that forward premia for up to six months remained upwards of 2.5 per cent.

It was only at the 12-month level that forward premia was below 2 per cent.

Traders said that one of the major factors for this trend was the delay in export remittances into the country. Unlike the past, traders said exporters had stopped taking forward cover for their inward remittances.

Instead, most of them preferred to leave their positions open, despite the firm spot rates.

This was partly on account of expectation that the high forward premia reflected a weakening of the rupee against the dollar.

Credit demand: In addition, credit demand also had a substantial influence on yields. Retail credit growth continued to be strong.

But there are fears that a slowdown in credit offtake could be in the offing if the current pace of interest rate hikes is pushed forward.