No surprises for bond market

Written by Mahalakshmi Hariharan | Updated: Jul 28 2010, 05:29am hrs
Having already priced in a 25-basis points increase in the repo rate, the reaction from bond markets to Tuesdays rate hike by the central bank was moderate. The yield on the ten-year benchmark bond rose by just 6-7 basis points following the Reserve Bank of Indias (RBI) move to increase the repo and reverse repo rates by 25 and 50 basis points, respectively. The 10-year benchmark paper, carrying a coupon of 7.80% and maturing in 2020, rose by about 5 basis points to end the session at 7.72%, compared with 7.72 on Monday, though it crossed 7.74% during the day.

Said Hitendra Dave, head, global markets, HSBC Bank, While bond yields have not been impacted in a big way, we saw traders squaring off their positions, following the announcement of the policy. Moreover, it should be remembered that dealers had pared their positions somewhat before the policy. The yields have moved up by 6-7 basis points. We will have to see how the shorter end of the curve pans out but with liquidity expected to remain tight, we expect bond yields to trade at 7.80-8% during the course of this quarter.

Added Joydeep Sen, senior vice-president, advisory, fixed income, BNP Paribas India Wealth Management, The market had already discounted a series of rate hikes and that would not make much of a fresh negative impact on yield levels. Over a period of time, about a year from now, yield levels would come down on lower fiscal deficit and lower government borrowing programme. We believe RBI would be more or less through with rate normalisation by then.

At the same time, treasurers expect rates on certificate of deposits (CDs) and commercial paper (CPs) to rise by a good 30-50 basis points on account of a shortage of liquidity.

Going forward, we expect rates on 1 year CDs, which are currently trading at 7.10-7.15%, to rise by about 30-50 basis points as liquidity tightens, and they could soon trade at 7.25-7.50%, said HSBCs Dave.

RK Gurumurthy, head, trading, ING Vysya Bank, observed, Liquidity appears to be designed to be in deficit mode, as I glean from the policy document and this could be to manage inflation concerns. However, we do have around Rs 50,000 crore of liquidity coming into the system, in the next four days on account of redemptions and expenditure from government towards salaries. This should tilt the balance to either a neutral or a very small negative mode. Over a 1-2 month horizon, liquidity is expected to oscillate between small positive and small negative until the central bank draws enduring comfort on the inflation front.

RBI on Tuesday said the idea was to actively manage liquidity to ensure that it remains broadly in balance and that excess liquidity does not dilute the effectiveness of policy rate actions.

With liquidity somewhat in short supply, RBI had, towards the end of May, allowed banks to maintain a lower statutory liquidity ratio of 0.50% and also to raise funds from it through a second liquidity adjustment facility (LAF) window till July 2. This facility was further extended to July 16, 2010 and again to July 30, 2010.

The apex bank will now continue to conduct two LAFs every day, allowing banks to access funds from it. Moreover, the central bank has also cut down the size of treasury bill auctions and bonds. In all, close to Rs 1,00,000 crore had moved out of the banking system, on account of payments for telecom licences and advance taxes.