Bond Market Insight-Government bond auction results: yield curve moves up

Tuesday\'s government bond auction indicated that the MoF has allowed a pick-up in the yield curve of some 1-2ppt from the previous auction a week ago, presumably for the sake of larger proceeds. Yesterday\'s proceeds amounted to UAH3.33bn, up nearly 3x from the UAH1.12bn realised on the 23 March auction. Of note, buyers poured UAH2.09bn into the paper maturing in less than a 10-month period, for which they will realise an increase in yields on the short end of the curve of 0.2-0.4ppt, towards a level of 11.4-12.9%.

Such record-high proceeds per auction so far this year so far, and the fact that buyers still seem to prefer short-dated securities (evident during the last two auctions, when a sizable portion of the total funds participating in the placement were channeled into the short end of the curve) indicate some fragility in the recent improvement of investors\' perception of sovereign risk. Firstly, the fact that some of the larger-volume buyers are placing their funds in the short-dated paper questions the viable prospects for improvement in the government\'s fiscal credibility over the medium term (more than 1 year). Secondly, by borrowing on sizable maturities of short-term bonds that fall due in April-May, the government has been shifting repayments for these notes into the near-term future, so the issue of sizable local currency repayments will resurface at the end of this year and in 1Q11. This will serve to prevent the yield curve from sliding downward, as was evident in the mid of this March.

Furthermore, the fact that the government is going to issue UAH20bn of the so-called VAT bonds, which will substitute the overdue VAT refunds from the government to the exporters with a tradable security, will bolster the pipeline of government debt offerings, which will eventually provide some resistance to, firstly, local currency government debt price appreciation, and hence, to a decline in the yield curve.