Bond yields soar on rise in global oil prices .

Bangalore, April 11 Bond yields soared last week powered by skyrocketing oil prices as traders awaited another rate hike, prior to the Credit Policy.

Inflation remained stubbornly stuck to double digits. Food price inflation is currently at 17.7 per cent after a brief retract. Firming global oil prices mounted further pressure on inflation. India's oil import basket price last weekend was $84 a barrel ($615 per tonne) as against the March average of $76 a barrel. India currently imports about 2.8 million barrels a day, according to data available from the International Energy Agency. This translated into a foreign exchange demand of about $2.4 billion a day for oil imports alone.

What masked this inflation was exchange rates. The rupee appreciated by 11 per cent over last year. The appreciation was led largely by non-debt capital inflows. FII net inflow into equities was $805.73 million (Rs 3,610.7 crore) ,which in turn pushed up the exchange rate to Rs 44.35 (Rs 45.14).

However, forward premia moved in the opposite direction. Forward premia for one, three, six and 12 months ended the week at 3.28 per cent (3.09 per cent), 3.43 per cent (3.26 per cent), 3.44 per cent (3.13 per cent) and 3.23 per cent (2.94 per cent) respectively. Traders said that the movement was largely triggered by corporate hedging against their External Commercial Borrowings servicing obligation and by oil importers. Short forward premia (cash to spot), however, eased to 2.46 per cent (4.17 per cent), as foreign banks restrained arbitrage operations. The restraint was partly on account of rupee funding support to global bidders for the 3G telecom spectrum auctions. Foreign banks mostly sold dollar and bought rupees through outright transactions for supporting the bids. The non-deliverable forward (NDF — offshore rupee trading, where settlements are normally done in dollar ) rate rose to Rs 44.44 (Rs 45.13), above the one month forward rates.

Although the RBI stepped into the foreign exchange markets twice during the week, interventions were restrained. The high inflation imposed intervention constraints on the central bank. This was in view of the impact on money supply. Heavy interventions in the past were supported by a low inflation environment.

Liquidity overhang

Despite muted intervention, financial markets remained inundated with liquidity. The liquidity partly stemmed from redemptions of short-term loans advanced by banks towards the last fiscal year-end. The liquidity overhang was apparent from the high recourse to the reverse repurchase (sale of securities) window of Rs 1,15,295 crore at the weekend Liquidity Adjustment Facility auctions.

The high liquidity had its impact on the Treasury bill auctions. At the 91-day T-bill auctions, the cut-off yield dropped to 3.97 per cent (4.38 per cent) and the weighted yield to 3.93 per cent (4.34 per cent). T-Bill 364-day yield at 5.06 per cent stayed above the repo rate.

However, despite the comfortable liquidity, the response to the first government borrowing auction for Rs 12,000 crore for this fiscal, through placement of 6.85 per cent 2012, 6.35 per cent 2020 and 8.26 per cent 2027 was a near rout. The ten-year paper devolved on to primary dealers. The papers were placed at 5.98 per cent, 7.96 per cent and 8.29 per cent. The ING Vysya Bank's Head of Treasury, Mr R.K. Gurumurthi, said, “With higher yields expected there is no demand for this series of the ten-year paper.” The low demand was evident from the ‘bid to cover' ratio of just 1.5 times the notified amount for the paper. The average ‘bid to cover' ratio for the first government auctions though was 2.27 times higher and even better in the case of the T-bills. The ‘bid to cover' ratio for the 91-day T-bill was four times higher implying a bias for short-term papers.

The bias resulted in pushing up the ten-year Yield to Maturity to over 8 per cent (7.79 per cent) on a weighted average basis last weekend.

Average daily trade volume rose to Rs 13,200 crore (Rs 10,100 crore) despite the low interest from banks. Traders said insurance company interventions, particularly the Life Insurance Corporation of India, supported the markets. LIC, traders said, was active in switches, (swapping short-term securities for long dated securities). LIC's aggressive purchases also pushed the yield spread between one and 10 years to 305 basis points (279 bps).

But the outlook remained uncertain. The Bharti Axa Asset Management's Head Fixed Income, Mr Sujoy Kumar Das, said, “We think the ten-year YTM will remain in the 8-8.25 per cent range for the present.” The uncertainty in the markets stemmed from possible response to soaring inflation. While banks have opposed any hike the Cash Reserve Ratio, bankers admitted there were few alternatives. The CRR option would provide some leeway for the RBI to intervene in the foreign exchange markets, they said. Rate responses through hikes in the repo rate or the reverse repo rates are likely to create imbalances.

But currency carry trades were migrating to short-term government and public sector securities, compounding the liquidity overhang. Traders said cross border investors also showed interest in public sector debt papers. The interest was on account of the high yields on the papers. PSU papers currently offer yields of up to 9 per cent. The interest in the PSU paper was reflected in spreads thinning between sovereign and Triple “A” rated corporate papers to about 75 basis points. Risk aversion from cross border investors has waned since last year when spreads were as high as 150-200 basis points.

This spread though could widen, as credit off-take picks up. Banks are bracing for a 20 per cent credit growth push, largely to farm and rural sectors. This credit push could, in turn, impact bonds as the initial funding is likely to come through sale of securities. But cross border currents also are likely to play their part. Impending sovereign default of some European nations are likely to trigger the correction.

Source : Business Line