Medium, long-end spreads contract further, says I-Sec

Our Banking Bureau

Mumbai, Nov 20: The sovereign yield curve witnessed another bout of re-alignment in the inter-segment spreads over the course of the week. Though the short-end (1-3 years residual maturity) remained almost flat at the previous week’s level, the medium (3-7 years) and the long segments (greater than 7 years, particularly the 10-year plus segment) of the curve moved down significantly, ICICI Securities said in its mark to market for the week ending November 24.

The trigger for the latest round of re-alignment was the benign composition of the auction-list, against the backdrop of continued comfortable liquidity. Issuance of floating-rate bond, which is sure to elicit good demand from the banking sector in view of its short maturity and utility as a tool for hedging against upward movement in short-term interest rates, was a big positive surprise for the market.

The drastic drop of international crude oil prices to two and a half-year lows, with its obvious implications for the trade balance and domestic inflation, added to the bullish sentiment.

The charge at the long-maturity segment was led by, once again, the securities at the far-end of the curve, which dipped by as much as 16-21 basis points. The benchmark 14-year security, GoI 9.85 per cent 2015, was the out-performer, with yield on the security dropping by 21 basis points. The 10-year benchmark, yield on GoI 11.50% 2011, declined by 13 basis points during the period to 8.52per cent currently.

The one-year Treasury bill yield, on the other hand, moved up by 3 basis points to 6.83%. Thus, the 1Y/10Y spread, which was ruling at 204 basis points previously, currently stands at 187 basis points. The central bank conducted a price-based re-issue of GoI 9.85% 2015 security for a notified amount of Rs 4,000 crore on Monday. The auction got a cut-off of Rs 109.83 and was fully-subscribed.

The security, which has become a benchmark and has been consistently among the top-traded securities, is expected to generate good bidding interest. The apex bank will also issue Rs 2,000-crore of 5-year floating rate bonds on Wednesday through uniform price-auction. With these issuances, Rs 103,750 crore of the gross borrowing programme, or 87 per cent of the budgeted amount, will stand completed.

The liquidity position in the money market stayed comfortable during the last week and call rates were range-bound between 6.5 per cent and 6.8 per cent . In the current week too, liquidity is expected to remain comfortable, despite the imminent Rs 6,000 crore auction-outflow.

The average unavailed refinance (Rs 3,900 crore) and repo subscription (Rs 4,300 crore) over the last reporting fortnight suggest adequate liquidity in the system to absorb the outflow. I-Sec expects call rates to hover in 6.5-7.5 per cent range in the current week.

The profile of the government expenditure and revenues suggests that even after Wednesday’s auction the continuance of WMA at high levels could necessitate two more large-sized auctions by the advance-tax outflow in mid-December.Considering that these auctions will be concentrated at the extreme-segment of the curve and the 10Y/20Y spread already has narrowed to around 65 basis points, further gains from this segment can be ruled out. And caution should be adopted in taking trading exposure here.

With this in mind, I-Sec suggest exiting this segment in favour of securities with around 10 years of residual maturity.