Falling yields in T-bills

The government must have taken a sigh of relief following a meteoric drop in the treasury yields in the last treasury auction held on Wednesday. In consideration of a sudden 50 bps cut in the discount rate in the last monetary policy, the cut-off yields on three-month, six-month and 12-month paper fell by nearly 46 basis points (bps), 50 bps and 54 bps, respectively, compared to the previous t-bill auction held before the monetary policy announcement. The cut-off yield on the benchmark paper fell to 13.28 percent-- the lowest level since the auction held on November 17, 2010. Against the pre-auction target level of Rs 170 billion, the auction drew one and a half times the pre-auction offer amount which was also 1.3 times that in the previous T-bill auction. However, the cash-strapped government closely followed its initial sales plan, as it accepted Rs181 billion worth of bids. The higher participation level came against the backdrop of Ramazan. This is attributable to investors growing motivation to lock their funds at the current yield level, as there is a broad consensus amongst market participants that interest rates have now peaked and a reversal is imminent. Therefore, the appetite for the 12-month sovereign papers was high, amounting to around Rs159 billion, accounting for 64 percent of the total participation level. Moreover, money market dealers have also linked better liquidity levels to the OMO injection worth Rs86.7 billion and inflow of money back into the system after 1st Ramazan- when zakat is deducted from deposits. There has been strong competition between investors to garner the longest tenure paper. This is clear from the bidding pattern, which suggests that the lowest and the highest bid placed on the 12-month paper were lower by 59 bps and 54 bps, respectively, compared to the previous T-bill auction. The current market behaviour depicts further cuts in the discount rate down the line. "A single 50 bps cut will not yield the desired result until and unless it will be followed by further monetary loosening", according to a money market dealer, adding that the future direction of discount rate cut also depends on the macro-economic condition in the future, which will become more apparent in 2QFY11. However, the cherry on top is the declining oil prices, which will help ease inflationary pressures. If that is the case, the monetary policy board members should brace themselves for pressure since the government and business community will definitely rally for a lower cost of borrowing.