Bond yields to range trade in anticipation of Budget and monsoon: Jajoo

Bond yields continued to trend higher on delayed monsoon concerns as the month of June received one of the lowest rainfall in the past decade increasing the possibility of a drought like situation in the key sowing parts of the country. The market sentiments generally remained weak amidst continued firmness in international crude prices due to ongoing political unrest in Iraq. As Brent crude prices nudged closer to $115/bl early in the week, benchmark 10-year government security yield rose to 8.77%  paring most of its post-election gains. However a moderate easing of global crude prices following comments from Iraqi authorities on increasing the oil production next month prompted some value buying in gilts. As a result the 10 year bond rallied to 8.67% but could not hold on to its gains on resumed selling pressure. The concerns over a possible rise in food inflation re-emerged as agriculture ministry official commented that kharif crop output was likely to fall by 30% resulting in market extending losses further with 10-year finally closing at 8.75% up by 3 bps for the week from 8.72% last week.

 
Aided by a broadly stable liquidity situation during the quarter end, corporate bonds remained supported with 10 year AAA bonds ending flat at 9.14%, while five year AAA yields fell 1 bp from 9.19% to 9.18%. The rupee remained unchanged at 60.19 as month-end dollar demand weighed on the currency. In terms of other developments during the week, the new government hiked passenger rail fares by 14.2% and rail freight charges by 6.5%. RBI released Financial Stability Report wherein it stated that the economy was likely to reap benefits from political stability and decisive government action. It reiterated that inflation expectations are expected to ease on anticipated government policy. It highlighted concerns over current account and fiscal deficit in FY14. The report also indicated RBI’s intent to reduce statutory liquidity ratio further to ease liquidity. US Q1 GDP in its final revision contracted sharply to 2.9% from (-1%) in its previous estimates followed by weak spending data. This led to decline in US 10 year bond yields to 2.52%.

 
Although the liquidity situation was broadly comfortable there was some volatility in overnight collateralised borrowing and lending obligation rates due to quarter end considerations. They hovered in a wide range of 8.25% to 8.90% during the week. On account of advance tax inflows government did not have any outstanding loans with RBI for the week ending June 20. The liquidity adjustment facility borrowings rose to Rs 18,663 crore from Rs 11,626 crore. No borrowings were reported from the marginal standing facility window. The regular 14 day term repo was rolled over at weighted average rate of 8.33%. No additional term repo auction was conducted. The short end rates were more or less stable with three month PSU Bank certificate of deposit rates ending marginally higher by 1 bp to 8.57% from 8.56%, while one year CD rates closed lower by 1 bp from 8.92% to 8.91%.

 

Government bond yields are trading near their highs of pre-election scenario, the upside risks seems to be limited as the negatives emanating from the probability of a drought like situation are likely to be countered by strong government action. Further the international Brent crude prices have also cooled from its highs of $115 to near $113. Since the participants are keenly awaiting the Budget and progress of monsoons, bond yields are expected to trade in a narrow range of 10 bps. The shorter end of the curve may ease further as overnight rates will normalise near the repo rate with the beginning of a new quarter.

Mahendra Jajoo is executive director & CIO-fixed income at Pramerica Asset Managers