Highlights:

• Bond prices crashed abruptly after the central bank RBI tweaked policy rates – repo rate and reverse repo rates hiked to 5.50 per cent and 3.75 per cent respectively, a rise of 25 bps each.
• The 10-year benchmark paper 7.80% 2020 yield spooked 10 bps to close at 7.65 per cent over the week.
• IMF projected that India’s growth would accelerate to about 9.5 per cent in 2010 as robust corporate profits and favorable financing conditions would fuel investment.
• The liquidity pressures continue to be in place; however, it is likely to be moderate in the later part of this month; the call and CBLO rates firmed up.
• Food inflation eased; however, the overall inflation as measured by WPI is likely to have an upward impact after a hike in fuel prices.

View & Recommendation:

• The bond market will take cues from global policy moves, domestic liquidity conditions and inflation figures. The market has already factored into the next 25 bps hike in the July 27 review.
• Yields on Commercial Papers (CP) and Certificate of Deposits (CD) increased amid tight liquidity conditions and applicability of base rates which have increased the minimum borrowing rates.
• Ultra Short Term Funds may continue to see erosion of assets; temporarily, investments may move to Liquid Funds. As per June month figures, the Income Fund category saw an outflow of Rs. 1.34 lakh crore while the Liquid/Money Market category saw an inflow of Rs. 17,029 crore.

Broader Perspectives:

Bond Front

The bond played jittery amid thin volumes after the central RBI hiked policy rates ahead of it scheduled policy review on July 27, 2010. The volume in GoI securities as per NDS-OM platform reported an average of Rs. 8,240 crore. Throughout the week, the bonds remained at level higher than the last week close. Moreover, the higher than expected cut-off at the weekend bond auction led to an aggressive sell-off. In the early part of the week, the bond market rallied on expectation that food prices would fall following the good monsoon in the country. At the end of the week, the 10-year benchmark paper 7.80% 2020 yield inched up 10 bps to close at 7.65 per cent while 5-year paper 7.17% 2015 saw its yield up by 14 bps to close at 7.40 per cent. The other maturity bonds’ yields also moved up. The long term yields are unlikely to have any adverse impact as the market has already factored into the liquidity, inflation and global cues. Going forward, the benchmark yield will move into the range of 7.60-7.70 per cent with an upward bias. The market would also await the IIP figures due on Monday next week which would decide its course of action further. Moreover, the G-Sec spread in 1/10 year dropped to 188 bps from 197 bps recorded over the last week. The 5/10 year spread also shortened to 37 bps from 54 bps over the last week.

Bond Supply

The government auctioned bonds worth Rs. 12,000 crore in the concluding week. The auctioned bonds were the 7.17% 2015 for Rs. 4,000 crore, the 7.80% 2020 for Rs. Rs. 5,000 crore and the 8.28% 2032 for Rs. 3,000 crore. The cut-offs came in at 7.40 per cent, 7.67 per cent and 8.33 per cent respectively, much higher than the expected cut-offs. Moreover, the market will witness moderate liquidity on account of maturity of the 11.30% 2011 paper worth Rs. 34,000 crore on July 28. There will also be a break of regular bond auction next week. After this week auction scheduled on July 16, the market will have a break from auction as the next auction would happen on July 30, 2010 only.

Liquidity Desk

The liquidity as measured by bids for reverse repo/repo in the liquidity adjustment facility continued to be strained with an average of Rs. 52,146 crore borrowed under Repo while Rs. 118 crore was placed with RBI under Reverse Repo. The liquidity is likely to be moderate in the later part of the month. This month, the government will pay for bond 11.30% 2011 worth Rs. 34,000 crore maturing on July 28, 2010. Amid a tight liquidity scenario, the call rates moved to 5.60 per cent, up by 19 bps while the CBLO rate moved up by 134 bps to 5.49 per cent over the last week.

Corporate Bonds

The corporate bonds steady with range bound trading. While the 10-year corporate bond closed at 8.70 per cent, 1 bps up over the last week, the 5-year paper closed at 8.15 per cent, 1 bps down over the last week. Corporate bond yields are likely to trade at the current levels given a weak outlook for liquidity.