Treasury investors playing safe

Investors behaviour in the last treasury auction, held two days back, has clearly expressed where they see the discount rate in the upcoming monetary policy.
With inflation hovering above 13 percent, the market has largely been expecting the interest rate to remain unchanged on Saturday. However, this excludes a few participants who foresee the possibility that the discount rate may be slashed by 50 basis points.
In the second treasury bill auction of the current fiscal year, confident investors submitted bids worth Rs160 billion against the combined pre-auction target amount of Rs120 billion. Demand outstripped its target by 1.33 times; but was down compared to the previous auctions 1.95 times. In keeping with the auction target, the government accepted Rs122 billion worth of bids.
"Since the short-term liquidity was relatively tight in the market, this participation level was fairly normal," according to one money market dealer.
The weighted average yield on the 3-month, 6-month and 12-month paper remained close to 13.52 percent, 13.76 percent and 13.91 percent, respectively. The cost of borrowing on the 12-month paper remained unchanged, while it jumped by around four bps and two bps on the 3-month and 6-month paper, respectively, as compared to the t-bill auction held earlier this month.
Though the weighted average yield slightly inched up, it remained bound in a close range that auctions have been witnessing since June. The cost of borrowing, on the other hand, has inched up on account of lower participation and a higher auction target compared to the previous T-bill auction. In the July 12 auction, the government had received Rs175 billion of bids against an auction target of Rs90 billion.
However, investors have erred on the side of caution as the 12-month paper alone accounted for nearly 50 percent of the total auction participation. This apparent shift suggests that investors have hedged against reinvestment risk.
The discount rate has topped out at 14 percent. But since macroeconomic indicators are not expected to become more apparent till the end of 1QFY12, it is too early to predict the interest rate outlook for the current fiscal year, and therefore, the market is expected to remain clueless till then.
Yet, if interest rate is slashed this week, then this market-startling development would slightly fortify the economic outlook for the current fiscal year.