The Hindu Business Line : Bond yields soften on liquidity overhang

Traders said the flows were largely in anticipation of further cuts in the US Fed funds rate that is currently 4.5 per cent, when the Federal Open Market Committee meets this week. The net flows, last week, were in excess of $1.2 billion, a reversal of the four weeks’ trend.

As a result, the rupee moved up against the dollar to Rs 39.41, up from the previous weekend’s level of Rs 39.47. Traders said the flows triggered interventions from the Reserve Bank of India. However, forward premia firmed up to six months as importers took forward cover. In addition, corporates with external payment dues also took cover, taking advantage of the favourable exchange rate. Forward premia between one and 12 months firmed to 1.83, 1.52, 1.52 and 1.11 per cent respectively. In the previous week, the premia were 1.51, 1.11, 1.16 and 0.93 per cent respectively.

But traders said that with crude oil prices moving southwards, oil companies were large buyers. However, some of them were borrowing funds through collateralised borrowing and lending obligations and parking the same in short- term deposits earning arbitrage spreads of anywhere between one and 1.5 per cent. But the oil companies’ resort to treasury management has been prompted by the government’s reluctance to hike oil prices. The last time oil prices were hiked was when global prices were about $58 a barrel. Currently, with prices at $89 a barrel, no price hike has so far come through, squeezing their respective refinery margins.

The combination of these trends has brought back liquidity overhang to the markets. This was apparent from the recourse to the reverse repurchase window at the Liquidity Adjustment Facility (LAF) auctions last weekend. All the 11 bids were for reverse repos, amounting to Rs 6,965 crore. But the recourse to the reverse repos was also partly due to the reporting fortnight.

The resumption of external flows failed to reflect in the weekly Treasury bill auctions. At the weekly auctions, the cut-off yield on the 91-day Treasury bill was 7.52 per cent for the fourth straight week. The weighted yield was 7.48 per cent. But bids at the auctions were higher than the last three weeks. Competitive bids were Rs 2,609 crore and non-competitive bids were Rs 2,400 crore. The retention was Rs 3,900 crore. The cut-off yield on the 364 T-bill was 7.71 per cent.

The liquidity overhang, however, pushed down the ten-year yield to maturity, on a weighted average basis, to 7.88 per cent last week down from the previous week’s 7.94 per cent.

The undertone in the markets remained firm. Daily trade volume doubled to Rs 6,500 crore last week. Trading interest picked up and was concentrated mostly at the short-end of the yield curve. The favoured securities were the 7.55 per cent 2010 and the 11.30 per cent 2010. Both these were offered for switches by life insurance companies for long-term securities for the 8.33 percent 2036, where trade volumes have picked up.

The preference for short-term securities was also largely on account of the belief that credit off-take would pick up in the coming weeks. The Vijaya Bank Chairman and Managing Director, Mr Prakash Mallya, said: “Off-take is low at present but we think credit will improve in the coming weeks.”

In the meanwhile, the chase for gilt-edged assets by both banks and insurers has resulted in shrinking spreads. The spreads between one year and 29 years was just 50 basis points. The asset chase is expected to benefit the Rs 7,000-crore government borrowing slated for the week, through reissue of the 7.99 per cent 2017 and the 8.33 per cent 2036.

However, despite the chase, the one-year real yield continued to be upwards of 4 per cent. One reason for this was the inflation numbers on the basis of the wholesale price index. WPI-based inflation was 3.01 per cent. However, on the basis of the current oil prices, estimates are it could be closer to 7 per cent, after factoring in the cascading effect.

Another reason for the high real yield was the fear that yields would not be allowed to drop. In fact, most bankers expect that RBI would mop up liquidity through the cash reserve ratio (CRR). Cash reserve is maintained against deposits and is currently at 7.5 per cent. The hike was to mop up arbitrage flows.

Meanwhile, banks may further reduce deposit rates. Most banks have already told corporates that bulk deposit renewals would not be on the same terms as before. Deposits have grown by 26 per cent on a year-on-year basis. Credit-deposit ratio since the beginning of this year was down to 46 per cent, implying that net interest margins were beginning to suffer already. This implied that reduction in deposit rates were now imminent.