The Hindu Business Line : Bond yields harden on US sub-prime crisis, ECB curbs

But traders said hardening of yields also resulted from the Government’s fiat to impose end-use restrictions on external commercial borrowings of more than $20 million. This move coincided with the Federal Reserve Board’s step to keep the Federal Funds rates steady at 5.25 per cent. Fed Funds is the US inter-bank lending of overnight funds.

The government’s steps had some effect, though foreign inflows still continued unimpeded. This time the flows were from non-resident investors and depositors. As a result, forward premia remained steady at the previous week’s levels of 1.77, 1.87 and 1.89 per cent respectively for 3, 6 and 12 months. One-month forward premia, however, dipped to 1.18 per cent. The steady premia, traders said, was also on account of oil companies’ abstention from taking forward cover for their import payments. The anticipated inflows prompted the Reserve Bank of India to raise the Market Stabilisation Scheme ceiling to Rs 1.5 lakh crore. The inflows during the week prompted intervention from the RBI and simultaneous sterilisation operations.

At the weekend three-day Liquidity Adjustment Facility (LAF) auctions, the RBI mopped up Rs 19,625 crore through reverse repurchases. This was after the Rs 4,000-crore mop-up through the issue of MSS security 5.48 per cent 2009 and Treasury bill (T-Bill) auctions during the week. At last week’s T-bill auctions, the cut-off yield on the 91-day security was 6.56 per cent, up from the previous week’s 6.48 per cent. The weighted yields were also up to 6.48 per cent from 6.40 per cent. The actual mop-up was Rs 4,500 crore through the 91-day bill as against the bids (competitive and non-competitive) of Rs 6,795 crore. The aggressive liquidity mop-up operations pushed up the 10-year yield to maturity to 7.98 per cent on a weighted average basis last week, up from 7.91 per cent.

The mop-up operations shrank the daily trade volumes to Rs 6,400 crore on the CCIL trade counter. Besides, the bid offer spreads were also beginning to widen, implying declining interest. Bid offer spreads were wide at 15 basis points. Moreover, the yields spreads between one and 29 years dropped to 115 basis points down. Clearly, the outlook for bonds was bearish. There were other pointers as well. At the LAF auctions, there were 28 bids for reverse repos for Rs 52,070 crore. At the weekend, there were only 17 bids, and the amount had shrunk 60 per cent.

However, real yields remained high at 2.7 per cent though inflation rose to 4.45 per cent. But bankers said this was because inflation expectations were high in view of current oil prices that were $72 a barrel translating into a weighted average import price of about $66. Besides, depreciation of the exchange rate was also expected to add to inflationary pressures. Bankers said the exchange rate depreciation would reverse the liquidity overhang.

In fact, expectations are that liquidity would tighten in the coming weeks as the peak season begins. The HDFC Bank’s chief economist said, “Liquidity can be expected to tighten, as the peak season kicks in and foreign flows slow down.” The former has happened as banks have begun quietly liquidating their securities and stacking up cash through reverse repos, preparing for credit demand. As a result, incremental investment deposit ratios for most banks were well below the mandated statutory liquidity reserve ratio of 25 per cent.

The latter was also beginning as foreign institutional investors were liquidating their holdings to tracing their way back home for bailing out their exposures in the sub-prime. That another downturn is in the offing is evident from the put-call ratios in the equity markets, that remain dangerously close to 1.4, implying there would be more sellers for equities.

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