Bond yields laddered to 8 per cent level on devolvement

Highlights
• Benchmark bond 6.35% 2020 yield touched to 8.01 per cent on account of devolvement* in first week auction
• Primary dealers had to devolve Rs. 448 Cr. of 6.35% 2020 paper
• Food inflation rose to 14.50 per cent for data on Mar 27, 2010 against 13.86 per cent observed a week before
• Limits for Ways and Mean Advance (WMA) set at Rs. 30,000 Cr. for first half of FY and Rs. 10,000 Cr. for second half of FY
• Inflationary pressures (data to be available next Thursday) and Industrial Output data to influence the policy review due on April 20, 2010; inflation likely to be in double digits
• Market to witness an auction of Rs. 13,000 Cr. on Government Securities and Rs. 5,800 crore of State Development Loans (SDL) this week

*Devolvement - is a mechanism used by Reserve Bank of India as part of its monetary policy to counter the volatility in the price of Government Securities. Under this mechanism Primary dealers would have to absorb the underwritten amount, when the bid prices are unacceptable to the RBI.

Views & Recommendation:

• The weekly bond issuances are likely to impact the bond prices in a greater way; any further devolvement will put pressure on bond yields.
• Liquid Funds and Ultra Short Term Funds (erstwhile called as Ultra Short Term Funds) would see its yields rising from the current yield as shorter end of yield curve is likely to move up in near future once the policy rates go up.
• Investors having longer investment horizon (more than 2 years) should wait for yields to reach to 8.25-8.5 per cent level and can then invest in Income Funds.

Broad Perspective:

The week started with a cooling in bond yields; the 10-year benchmark 6.35% 2020 G-Sec slipped to 7.80 per cent on Monday, down by 5 bps over its last week closing. However, the sentiments went against the market and the yields rose to its three week highs ahead of first week auction of Rs. 12,000 crore and monetary policy tightening to contain high inflation.
The auction results disappointed the market and the benchmark yield passed 8 per cent mark to close at 8.01 per cent on account of devolvement. It touched to 8.03 per cent level, its highest in more than 17 months and a level it touched on Mar 22, 2010. The auctioned bonds got timid response and primary dealers had to devolve Rs. 448 crore of 6.35% 2020 paper. RBI set the cut-off yield of 7.9645 per cent for the 6.35% 2020 bonds. The other bonds were fully subscribed amidst high demand. Both received demands for more than two times. Due to devolvement, primary dealers demanded high cut-off yields. This week, the choice of securities will decide the momentum of bond yields and primary dealers will demand higher underwriting fees and higher yields in fear of devolvement of securities. Moreover, the subdued response on 6.35% 2020 bond is putting pressure on its existence as the benchmark yield and traders have been demanding for a new benchmark so that they could concentrate on the movement on interest rates instead of choice of a benchmark bond.
Inflationary pressures continue to remain intact; food prices accelerated for second straight week. The inflation based on primary articles rose to 14.50 per cent for the week concluding on Mar 27, 2010 against 13.86 per cent observed a week before. Industrial output data for February due on Monday and March inflation data on next Thursday are the factors which will decide the direction of RBI Policy review due on April 20, 2010.
Liquidity as measured by bids for reverse repo/repo at the Liquidity Adjustment Facility auction went to an average level of Rs. 1 lakh crore against Rs. 2,000 crore reported last week. Overnight rates also remained at the level of reverse repo rates due to high liquidity in the system.
However, Corporate Bonds yields saw an increased activity in the trading circles. Its spread over its counterpart G-Sec slipped in all categories. The 5-year and 10-year corporate bond spread over its counterpart G-Sec slipped to 76 bps and 63 bps from 81 bps and 82 bps respectively. The 10-year Corporate Bond closed at 8.80 per cent for the week concluding on April 09, 2010.
RBI set the limit for Ways and Mean Advance (WMA) at Rs. 30,000 crore for first half of fiscal year (April to September) and Rs. 10,000 crore for second half of fiscal year (October to March). WMA is a window through which the government borrows from RBI to meet mismatches between payment and receipts. Any borrowing within the WMA limit is done at Repo rate and over the WMA limit, it is done at Repo plus 2 per cent.