The Hindu Business Line : Bonds rally as liquidity, deposits surge

Markets remained awash with liquidity, largely on account of the reserve money expansion, inward remittances by non-resident investors and deposit build-up. Outlook bearish as markets see Fed rate cut, higher credit offtake

Bangalore March 11

Bonds rallied during the week on the back of a liquidity surge last week and accretions of deposits in the banking system ahead of the year end.

But traders were apprehensive on the sustainability of the current rally. This was largely in view of the international situation of firm oil prices and the stand-off between the US and Iran.

With these fears remaining dominant, foreign institutional investors have been sellers in the equity markets. Domestic institutions and funds have begun moving to support the equity markets by selling their excess stocks of Government securities.

Forward Premiums

The sell-off by FIIs, however, failed to impact the foreign exchange markets and the liquidity. This was apparent from the soft forward premiums. Forward premia from 3 to 12 months was between 3.5 per cent and 2.98 per cent. Traders said that some of the exporters and foreign direct investors were taking forward cover ahead of their inward remittances.

But at the short-end, one month, forward premia remained firm at 4.5 per cent. This was largely on account of interventions by the RBI in the forward market and swaps by foreign banks for meeting their rupee liquidity and reserve ratio requirements.

Markets remained awash with liquidity. This was largely on account of the reserve money expansion, inward remittances by non-resident investors and deposit build-up. The liquidity was evident from the week-end liquidity adjustment facility auctions.

At the auctions, the RBI mopped up Rs 26,485 crore. The liquidity was despite the twin auctions for dated securities of Rs 7,000 crore, through issue of the 8.07 per cent 2017 and the 8.33 per cent 2036 securities.

Liquidity Overhang

These securities were placed at 8.07 per cent and 8.40 per cent respectively.

Bids for these securities were close to Rs 20,000 crore, though only the notified amount was retained. Bids for the 29-year security were entirely from the LIC and private sector life insurance companies.

The high liquidity was evident from the weekly Treasury bill auctions. At the 91-day T-bill auctions the cut-off yield was fixed at 7.48 per cent. But the weighted average yield was set 34 basis points lower at 7.14 per cent.

There were no non-competitive bids at this auction. In fact, competitive bidders, banks and primary dealers, pulled down the weighted yield. As against the notified amount of Rs 2,000 crore (Rs 500 crore normal and Rs 1,500 crore as part of the Market Stabilisation Scheme), the competitive bids were Rs 2,843 crore. The trend, traders said, were largely on account of accretion of 90 day and 180-day bulk deposits, bankers said.

But non-competitive bidders have begun moving out into longer-term securities, particularly 182 day T-bills. Non- competitive bids for the 182 day T-bills was Rs 500 crore and the entire amount was accepted. The cut- off yield was 7.75 per cent. However, despite the short-term liquidity overhang, there was no impact on the 10-year yield-to-maturity (YTM).

The 10-year YTM on a weighted average basis hardened to 8.01 per cent last week as against 7.94 per cent last week.

Reserve Requirements

Trade volumes were mostly lifted by the jump in trades at the short-end. Some of the foreign and private banks, short of reserve requirements, picked up short-term securities from the secondary markets. The focus of these banks was on securities with residual maturities of a year, since most of them have marked-to-market portfolios.

As a result, volumes rose to about Rs 1,000 crore. But the interest from insurers pushed down yields at the long ends as well, though the volumes were small. This was because most of the interest in the securities markets was from the private sector life insurers.

Life insurance Corporation, the financial behemoth, focussed on supporting the equity market during the last week. The absence of LIC notwithstanding, the yield spreads remained low. The yield spread between one and 29 years was only 55 basis points.

Fed Rate Cut

The outlook remained bearish for the markets. This was largely driven by anticipation of a rise in US treasury prices, when the Federal Reserve Bank meets on March 20. FIIs and hedge funds have been pulling out in anticipation of a reduction in the Fed Funds rate from the current level of 5.25 per cent.

But any Fed rate cut was unlikely to impact the domestic environment, bankers said. This was because the primary focus of the Government and the RBI was inflation control. Inflation as measured by the wholesale price index was 6.10 per cent. This translated a one-year real yield of 1.6 per cent indicating a hardening of yields.

Moreover, bankers said that the critical factor influencing yields was credit off take. Last week's incremental credit deposit ratio was 64 per cent, despite credit growing by Rs 39,606 crore, almost entirely non-food credit. But bankers said that this was largely on account of accretion of bulk deposits. Redemption of the bulk deposits could reverse ratio and push it once more close to 100 per cent. Yields could also be driven up in the process. This is a situation that bankers are anticipating to unfold over the next few weeks.

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