C. Shivkumar

BONDS remained weak last week in the absence of buyers as inflationary worries dampened market sentiment.

What ensured that bond yields remained firm was the large-scale exit by foreign institutional investors from the equity markets and the foreign currency demand by oil companies in view of the hardening oil prices in the global markets, traders said.

Last week, FIIs remained large-scale sellers. Traders said the selling was largely driven by year-end concerns and in anticipation of the weakening of the rupee against the dollar on account of rising oil import bills.

Besides, there was little support from life insurance companies, who normally rush into the market when yields harden. This time most of them preferred to stay away.

Expectations are that they would abstain from large-scale purchases ahead of the peak season Credit Policy announcement.

Offloading by banks: Moreover, banks were selling securities to meet the foreign currency demand of oil companies for funding the imports of liquefied petroleum gas and other products.

As a result, the RBI had expected a low response to the Treasury bill auctions, prompting to fix a high cut-off yield.

The cut-off yield for the 91-day T-bill auction was 5.49 per cent, up from the previous week's 5.40 per cent. That the cut-off yield was on the higher side was evident from the weighted average yield which was 5.45 per cent, indicating that markets were still surfeit with liquidity. The 364-day T-bill was oversubscribed by almost Rs 4,000 crore. The yield on the 364-day T-bill was 5.85 per cent though on a weighted average basis it was lower by another 3 basis points.

Surplus liquidity: The surplus liquidity was also evident from the mop-up through the reverse repo operations of the RBI. Last weekend, it was Rs 9,200 crore.

Despite this trend, the 10-year yield to maturity remained steady at its low levels of 7.22 per cent on a weighted average basis, unchanged from the previous week's level.

The high weighted average was partly on account of banks placing their high coupon security, 11.43 per cent 2015 , for sale at yields as high as 7.29 per cent. It was these high yields, bankers said, that prompted the RBI to cancel the auction for raising Rs 4,000 crore through 15-year bonds since any issuance would have resulted in the YTM rising to close to 8 per cent.

Weak undertone: Traders said that the undertone remained weak, evident from the flagging trade volumes.

Trade volumes towards the weekend fell below Rs 1,000 crore per day, the lowest level since 2001.

As a result, the outlook for bonds also remained bearish for the coming weeks.

The weak sentiment was evident from the wide spreads between one and 23 years. It was 190 basis points last week, similar to previous week's level.

Traders said that the weakness in the bond markets could not be attributed to liquidity concerns, in view of the good response to the reverse repo auctions. The concerns were more driven by large-scale credit demand. Credit is currently growing at 33-35 per cent clip on a year-on-year basis. What also triggered the rush for credit during the last few days was the RBI conceding bankers' demand for allowing the Investment Fluctuation Reserve as Tier I capital. This automatically allowed banks to further expand their credit portfolios, since most of their capital to risk weighted asset ratios have suddenly increased. The average industry CRAR was about 12 per cent and would now increase closer to about 13 per cent. As a result, few bankers showed little interest in investments. In fact, most bankers prefer to wait for the Credit Policy.

Remaining liquid: The preference was to remain liquid at all times, without increasing the liabilities. Consequently, more bankers are further shrinking their average tenors closer to private sector bank levels of about two years.

Besides, with inflation rising to 4.24 per cent, the one-year real yields are one per cent below the globally accepted levels. Consequently, traders said that yields could fall further in the coming weeks.

Bankers said that the rupee depreciation was unlikely to be sustained, since it was an entirely oil and FII-driven impact. That the long-term outlook appears positive was clear from the fact that forward premia even for one month was below one per cent.

Forwards drop: One reason for this drop in the forward premia, bankers said, was the sudden rush by exporters to take cover due to weakening of the rupee. Despite the FII outflows, the net foreign exchange reserves have actually increased by $294 million. This trend could accelerate in the coming weeks, if oil prices decline as expected, bankers said.

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