Domestic bond yields take cues from US, UK

Highlights:
• Ten year benchmark bond 7.80 per cent 2020 closed at 7.49 per cent touching its Dec figures, down by 15 bps from 7.64 per cent reported last week
• US $ 1 trillion EURO and IMF rescue package to Euro-Zone failed to cheer the world market post announcement
• Flight to Safety witnessed where the money moved out of emerging markets and fled back to US, UK and Germany bonds; yields touched their six-month lows
• India’s headline inflation as measured by Wholesale Price index (WPI) eased to 9.59 per cent in April from 9.9 per cent a month ago
• Liquidity traded at a daily average level of Rs. 28,749 crore
• Income category funds saw an inflow of Rs. 1,77,773 lakh crore in April as compare to an outflow of Rs. 1,64,487 crore as per the data released by AMFI

View &Recommendation:
• Bond yields continue to move down tracking the spurt in buying of US, UK and Germany bonds. The Euro crisis failed to settle down even after the announcement of a rescue package of US $ 1 trillion by other European Union and IMF. The shock waves sent by Euro zone are affecting the currency markets which may lead to a fall in EURO. Equity markets too fall in line with all major world indices going southwards.
• Looking forward, the lower end of the yield curve will continue to trade in range bound. However, in long term, the bond yields may witness upward revisions due to continuous supply of papers.
• The top recommended funds in Ultra Short Term category (erstwhile called as Liquid-Plus Funds) are IDFC Money Manager – Invest Plan – Plan A, HDFC Cash Management Fund – Treasury Advantage and Kotak Floater Fund while in Liquid Fund category, the recommended schemes are HDFC Cash Management Fund – Savings Plan and Reliance Liquidity Fund.

Broader Perspectives:
Though India’s headline inflation figure based on Wholesale Price Index (WPI) narrowed to 9.59 per cent in April from 9.90 per cent a month ago, the government continues to worry from the high figures. The Chief Economic Advisor says that Inflation will continue to fluctuate over the next three months before it starts falling steadily. The WPI topped the 10 per cent mark for the first time in 15 months in February. The higher than the expected inflation put upward pressure on yields. The Industrial Output data as measured by Index of Industrial Production (IIP) slid to 13.5 per cent in March against the market expectation of 15 per cent; manufacturing output grew 14.3 per cent in March compared with 16.1 per cent in February.
The benchmark bond 7.80 per cent 2020 yield dropped below 7.50 per cent level. It closed at 7.49 per cent touching its December figures, down by 15 bps from 7.64 per cent. The G-Sec spread of 10-5 years maturity bonds narrowed to 23 basis points from 27 bps a fortnight earlier. However, the 5-1 year spread widened to 214 bps from 165 bps reported last fortnight. G-Secs rallied following a fall in US Treasury yields, lower IIP and WPI figures. The most traded G-Sec 8.20 per cent 2022 saw yield falling to 7.74 per cent, down by 11 bps. The higher than the expected revenue from 3G auctions will help reducing the high borrowing program. The government is expected to raise Rs. 50,000 crore as against the expected figures of Rs. 35,000 crore. If 2G recommendations as suggested TRAI are implicated by the Telecom Ministry, the government will add additional revenue to its chest. The government issued Cash Management Bills of worth Rs. 6,000 crore at a cut-off yield of 3.87 per cent to pay off its bond redemptions.

The week saw an auction worth Rs. 12,000 crore of Government Securities namely 6.85% G-Sec 2012 (Re-issue), 6.35% G-Sec 2020 (Re-issue) and 8.26% G-Sec 2027 (Re-issue) for a notified amount of Rs. 5,000 crore, Rs. 5,000 crore and Rs. 2,000 crore respectively. All the securities were auctioned off successfully at cut-off yields of 7.24 per cent, 7.54 per cent and 8.22 per cent. There was no devolvement to Primary Dealers. However, the appetite among bond buyers seems to be dampened as the bid to cover ratio slipped below 2X despite a strong bond rally. The 10-year benchmark paper was subscribed to an extent of 1.58 times only. However, there was a strong demand on shorter tenure paper. The bond 6.85% 2012 was subscribed by around 3 times.
Liquidity as measured by bids for reverse repo/repo in the LAF (Liquidity Adjustment Facility) averaged Rs. 28,749 crore against last week average of Rs. 55,491 crore. Banks were also reluctant to lend to each other following weak credit sentiment in the market. The average Call and CBLO rate increased to 3.79 per cent and 3.68 per cent from 3.74 per cent and 3.32 per cent reported last week.

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.