Weekly Debt - Sovereign yields ride a roller-coaster on policy uncertainty

 

Sovereign yields ride a roller-coaster on policy uncertainty  

n         This week's trades pared most of the gains of the previous week with participants resorting to profit-booking as the rate cut rumor lost steam. The week started on bearish note as various announcements by the apex bank hinted markets of a silent policy, on January 27. With lack of any positive news and on the back of profit booking, benchmark yield rose 42bps from the week's open, to clinch an intraweek high of 6%. It closed lower at 5.72% as investors gained confidence from PM's economic panel's statement on a silent policy but further rate cuts.

n          As the market has turned volatile participants shifted their bias from the long maturity bonds to the liquid 10-year paper. This has mopped up volumes from the tail of the yield curve as investors reshuffled their portfolio and offloaded high-duration bonds to avert huge MTM hits. Volumes in the 10-year benchmark bond rose to 61% of total NDS-OM trades, much higher than 49% in previous week.

Cash flows undeterred; Corporate bond activity sustains volumes   

n         Liquidity conditions enhanced to levels of daily average excess cash worth INR 505.46 bn in RBI's reverse repo, more so as participants refrained from any directional trades on the back of looming uncertainty prior to the policy. Banks expressed comfort as LAF repo reported no bids, while mutual funds too maintained a cash comfort in the absence of any borrowings under the special term repo facility. Average overnight (o/n) rate hovered in the range of 4-4.10% over the week.       

n         Corporate bonds accounted for majority of trades in the non-SLR segment, reporting daily average volumes of INR 13.37 bn (nearly as much as previous week). The average primary issuances in the CD segment were lower by INR 3.72 bn (at INR 6.48 bn) over the previous week; most of them belong to the 6-month maturity. MFs expressed dominant investor interest in these issues more so after the SEBI guideline that seeks to confine the maturity of liquid fund investments to less than 182-days by February 01, 2009. EPFOs and Insurance companies' buying activity picked up significantly in the non-SLR segment, their bias witnessed towards corporate bonds.

Policy expectations

In line with the in-house view, we expect the key policy rates to remain unchanged, reaffirmed by PM's economic advisory panel's statement for no policy cut. RBI, as a pre-policy measure slashed the policy rates 100bps and CRR 50bps on January 2. While the market speculates a cap on reverse repo bids or the cash to be parked under the LAF, it seems unlikely as understood from RBI's previous attempt (in 2007) at the same shifted bank lending to the overnight money market, suppressing the call to sub-1% levels.

Outlook

n         The post-policy market reflex would be greater certainty for interest rate anticipations. Trajectory for the sovereign yield curve, as participants are assured of the interest rate movement, would witness a definite downside. Investors would be expected to initiate fresh trades, channelizing their resources towards assured returns from a rally in bond prices. Volumes in long-end of the curve are likely to shoot up, even as it may steepen further as participants build fresh expectations for the next rate cut.    

n         With mounting expenditure, dismal tax collections (direct and indirect) and the inconclusive 3G auction, we can expect an additional borrowing of INR 150-200 bn in final 45 days of the FY09 (after the exhaustion of the current borrowing programme). This would only be a temporary jerk to the investor sentiment since the yield movement would primarily be governed by the definite further decline in key policy rates, sustaining the downside bias on yields.