LONG END & SHORT END MOVING IN OPPOSITE DIRECTIONS
Short End & Long End of the curve are moving in opposite directions. Reasons are obvious and some of them can be traced to the same economic and commercial activities happening in the markets. Like better than expected ( almost double) collections in 3 G Auction of Rs.68000 crs is one of the reasons for positive movements in the long end of the curve; whereas short term borrowings by the Telecom Companies (Telcos) to bridge their financing requirements by May end are creating ripples in the short end of the curve.
When I last published my note on AXIS Short Term Plan on May 14’2010, rates at the short to medium term were as follows ( as on May 12’2010) :
| May 12’2010 | May 21’2010 | |
| 3 MONTHS | 5.00% | 5.75% |
| 6 MONTHS | 5.30% | 6.10% |
| 1 YEAR | 6.23% | 6.45% |
| 2 YEAR | 6.93% | 7.02% |
| 3 YEAR | 7.30% | 7.35-7.40% |
As can be seen from above, short end rates between 3 months to 1 year have gone up between 70-75 bps to 20-25 bps already in a very short period of time. This sudden spurt in yields can be attributed to the temporary borrowing being undertaken by most of the Telcos who had successfully bid for 3 G auction & have to shell out funds before May 20’2010. They are allowed to raise cheaper funds through ECB route within 1 year from now. Hence, this temporary bridge financing has shot up the 3 mths CP to 1 year CP & CD rates. Tata Tele raised one year CP at 7.25% & AIRCEL has raised the same tenor CP at 9.75%.
Also, Rs.68000 crs raised under 3 G auction is likely to be going out of the system ( till Govt does not start spending ) & going into the Govt coffers. This is going to create a mismatch of cash flows in the system. This coupled with advance tax outflows might take systemic liquidity into negative. In such a scenario, the banking system also might redeem their MF investments of close to Rs.1 lac crs parked by them in liquid/liquid plus schemes. In such a scenario, we might see the banks accessing the REPO window at 5.25% levels for a short while.
All the above will give ample opportunities to the Fund Managers to invest in 1-3 year papers in much higher yields when short term rates peak off mid June’2010 & creating a slightly higher average maturity profiles of between 1.50 to 2 years. Most of the Fund Managers ( not necessarily all) would have booked their profits in their CP/CD & 2-3 year papers by now & should be sitting on cash to take advantage of these developing situations.
Another factor which will be determined by the demand/supply situation post July 01’2010 (post the new SEBI guidelines kicking in for valuing securities on MTM basis) is the valuation of papers between 91-365 days. If most of the liquid plus schemes shy away from taking slightly higher average maturity/MTM calls in their liquid plus schemes, these papers will have no takers for some time.
Hence, one needs to carefully study impact of all these factors on the shorter end of the curve before investing in short term plans going forward. If at all, one can take a call of exiting aggressive short term plans which have higher average maturities & higher component of MTM papers & stay invested in those schemes which were lower in duration/ invested more in CDs ( with in built profit like AXIS Short Term Plan & Kotak Bond STP, which can be sold at profit) & those schemes which have already booked profits & sitting on cash (like Canara Robeco Short Term Plan which has booked profits on their CP/CD & NCD portfolio & sitting on 50% of the portfolio in cash).
I would recommend investment in this asset class with at least 6 month view starting second week of June’2010.
As against the above, another interesting story is unfolding on the longer end of the curve. I had first given following reasons for looking at the longer end of the curve as early as December 07’2009. I had mentioned following reasons for looking at the longer end of the curve:
“Once Again an Investment Opportunity at the Long End & Why:
• It is that band of the trading zone ( mentioned in my November 03_2009 note) when one can look to invest at the long end for following additional reasons
• As mentioned above, any rate hikes or CRR hike will have an immediate impact at the short end rather than the long end
• Year end buying by Insurance companies will boost long end rates
• Credit offtake still dismal which was evident when SBI cut their lending & deposit rates & the same was followed by other banks as well a few months back
• Next year Fertiliser & Oil subsidy should be on the lower side
• Hopefully no more fiscal stimulus packages need be announced in the next year which can increase the borrowing programme like in the current year
• If at all, fiscal & monetary stimulus packages might be rolled back gradually, giving rise to higher revenue collections & hence lower borrowing
• State Governments have collected a huge amount of approx.Rs.1 lac crores @8.50% in their small savings schemes; hence they also might have lower borrowing requirements next year
• With rise in GDP, revenue collections for the forthcoming years should improve dramatically
• Also, healthy disinvestment of PSU Equity figures which have been planned going forward alongwith collections from 3G Auction should also help in reducing Fiscal Deficit numbers”
As can be seen from above points, most of the reasons why I had thought long end of the curve should do well are panning out quite well one by one. Besides almost double the collections of 3G auction collections & healthier tax collections, there is still untapped potential on the disinvestment side. Also, with European crisis pushing demand for safe heaven government debt like US treasuries as well Indian treasuries, oil at $70/bbl, Indian bond yields have fallen to their lowest levels in last 5 ½ months; currently 7.80% 2020 is quoting at 7.33% against 7.55% on May 12’2010 & 7.80% when it was first auctioned in April’2010.
With better than expected collections of 3 G auction, there are rumors of either a couple of auctions getting cancelled or Govt borrowing programme getting truncated. Since we are in a similar situation like mini 2008 global crisis, RBI might have a rethink on their medium to aggressive rate hike stance to a slower pace of rate hikes. Also, there is a possibility of further hikes in FII limits of buying GILTs. All this will augur well for the long end of the curve. There might be a slight blip in this story in the month of June for reasons mentioned above affecting the short end of the curve as long end also might move in conjunction with short end due to depressed sentiments.
In such a scenario, 10 year benchmark may retrace some of the recent gains & bounce back to say 7.50% levels in June’2010; thereafter it can settle sub 7.25% levels. One can look to invest in long term GILT/Income schemes in mid June’2010 or once it starts retracing some gains from current levels.
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