US bailouts worsen inflation outlook

Bond markets are staring at a bearish phase on the back of the US government’s rescue plan for banks.

Having bailed out insurance giant AIG with $85 billion, the US government plans to pump in as much as $800 billion to rescue banks, which have been hit by the credit crisis. The move was prompted by the collapse of Lehman Brothers and steep falls in equity markets, not to forget a rise in short term money market rates.

Are you ready for a bailout

The $800 billion bailout plan helped equities recover. The US dollar fell, as bond yields and oil prices rose. US equities recovered around 10% of losses, while bond yields rose 40 basis points (bps) from lows and oil prices rose over 10% in reaction to the plan. The market reaction suggests that the plan is inflationary in nature with money being pumped into the system for worthless assets.

'Bailout won't affect AIG's India business'

The domestic bond market is likely to take its cues from the reaction of global bonds and commodities. The rise in oil prices from lows of $90/bbl to $104/bbl is a deterrent to yields.

More India business stories

Inflation as measured by the Wholesale Price Index came in at 12.14% for the week ended September 6 as against market expectations of 12.01%. Inflation is expected to remain at double-digit levels till the end of this calendar year. Inflation outlook received some respite from oil prices, which came off from $145/bbl to $90/bbl. The respite from oil prices may not last if the US bailout plan pushes up oil prices further. This would place in danger the Reserve Bank of India’s (RBI) inflation target of 7% for the current fiscal.

The RBI move to temporarily reduce statutory liquidity ratio (SLR) by allowing banks to access 1% of the net demand and time liabilities for funds from the repo window will dampen demand for bonds. The bond market will also watch out for the government bond auction calendar for the second half of the fiscal. The government will have to stick to its schedule despite additional payouts of over Rs 60,000 crore scheduled in the next couple of months.

Liquidity tightened considerably last week with liquidity as measured by bids for reverse repo/ repo in the liquidity adjustment facility (LAF) seeing bids for repo at 9% touching Rs 83,500 crore. The RBI had to temporarily cut SLR to allow banks to access the repo window for liquidity. RBI’s dollar sales in the currency market to prevent high depreciation of the rupee sucked out liquidity from the system.

Advance tax outflow of over Rs 30,000 crore is also creating tight liquidity conditions. Liquidity, however, may ease from Rs 83,000 crore negative to Rs 60,000 crore negative with banks well covered in their positions in the second week of the reporting fortnight. Bank strikes this week prompted banks to over cover their products last week. Call rates shot up to 15% levels on tight liqui-dity. Overnight rates could come off if demand for liquidity eases this week.

Government bonds

Government bonds saw yields move higher week-on-week. The benchmark ten-year bond yield closed the week higher by 4 bps with the 8.24% 2018 bond closing the week at 8.39% levels. The bond yield had touched lows of 8.05% during the week and has pulled back 34 bps from lows. The long bond, the 8.24% 2027 bond saw yields move up by 4 bps week-on-week to close at 8.79% levels.

The bond yield had touched lows of 8.35% levels during the week and has pulled back by 39 bps from lows. Bond yields are likely to trend higher as the market waits for the borrowing calendar.

Treasury bills, corporate bonds and overnight index swaps

Treasury bill (T-bill) yields were down last week with the cut-off on the 91-day T-bill auction held on September 17 coming in at 8.65% against 8.73% in the previous week. The 182-day T-bill auction saw the cut-off coming in at 8.77% against 9.08% in the previous auction. The RBI, this week, is auctioning Rs 500 crore of 91-day T-bills and Rs 1,000 crore of 364- day T-bill under regular auction.

Corporate bonds saw yields moving higher as government bond yields rose. Ten-year benchmark AAA yields were higher by 10 bps at 10.90% to 11% levels while ten-year benchmark bond spreads were higher by 2 bps at around 245 bps levels. The short end of the curve saw yields move up sharply with one-year benchmark bank certificate of deposits yields moving higher by 30 bps to 11.60% levels. Corporate bonds yields are likely to remain pressured on liquidity worries.