PD Fees Highest Since April as Overseas Pressure Raises Devolvement Fears

The cut-off underwriting fees for government bonds auctioned today rose to the highest level since April, as primary dealers turned wary of market appetite after overseas cues triggered a sharp fall in bonds in early trade.

The Reserve Bank of India set the underwriting cut-off for the three-year 6.20%, 2029 gilt at 2.00 paise today, the highest so far this financial year. The underwriting fee for the 6.57%, 2033 bond was set at 1.80 paise, while the fee on the new 2056 bond was set at 1.29 paise. The government offered 320 billion rupees worth of gilts at the auction today.

 These are the highest underwriting cut-offs seen since April 2, when the average cut-off on a 15-year paper was set above 7 paise, while that on a 50-year gilt was set above 10 paise.

 At the short end of the curve, the underwriting fee cut-off on a three-year bond was set at 1.78 paise on May 22, amid heightened geopolitical tensions between the US and Iran. However, for the rest of the financial year so far, underwriting cut-offs on three-year paper have hovered between 0.23 paise and 1.20 paise.

 Devolvement concerns among primary dealers increased as Brent crude surged above $108 a barrel overnight, while the US and Iran continued strikes on oil infrastructure, raising concerns about further supply disruptions.  The move also heightened concerns about imported inflation in India and strengthened expectations of monetary policy tightening by the Reserve Bank of India.

 Benchmark US Treasury yields have also risen amid growing expectations that the Federal Reserve will hike rates at its policy review next week. CME FedWatch shows a nearly 70% probability of the FOMC raising interest rates by 25 bps next week, up from around 50% a week ago.

Traders also see the yield curve flattening as markets price in higher policy rates. Furthermore, many traders expect the RBI to announce additional liquidity-absorption measures before its next policy review in October, as surplus banking-system liquidity has swelled to more than 10 trillion rupees.

 That has led some traders to see a risk of devolvement in the shorter-tenor gilts at today’s auction, particularly the seven-year paper. Banks generally avoid seven-year gilts for asset-liability management.

However, others expect banks to buy the securities for their trading and banking books, supported by the large cash surplus generated by FCNR(B) inflows.