Bond Market Insight-Government bond auction results: market heats up, yields cool down

During yesterday\'s bond auction, the MoF managed to sell all four bonds it brought to the primary market (see Table 1). While total demand amounted to a respectable UAH2.7bn, the MoF decided to limit supply, and raised only UAH747m, which was more than enough to cover this week\'s needs on local-currency debt redemptions of UAH505m, including interest payments.

The banking sector\'s liquidity built up recently (to UAH24.3bn as of early morning yesterday), and a further slide in money market rates alongside the NBU\'s move to reduce the 2-month deposit rate to 4% (down 3ppt, from 7% as of year-end 2010) all heped attract the sizable demand for the asset, the government bonds, and especially the short-dated securities yesterday.

Thus, a 3-month discount bond was sold to 11 bidders out of 29 looking to buy this particular bond, at a 5.5% yield, raising UAH271m. Those bidders who failed to buy the paper were seeking yields up to the 7.5% level. At the same time, the 6-month discount bond was sold to 10 bidders (out of a total of 29 who were ready to pour UAH845m into the bond), raising UAH242m and yielding 6.75%, or 25bp lower than the previous auction, when a bond with similar duration was sold at a 7% yield.

A bit less appetite seen from investors was seen in the medium term bonds, with the MoF in turn accepting only the most attractive bids, raising UAH34m from selling the 2-year bond due in March 2013 at a 10.28% YTM, and UAH200m from selling a bond with an embedded put option maturing in July 2016. The latter of the medium-term bonds sold yesterday provides the holder with the option to put the bond to the MoF and receive the principal every quarter starting after the fifth coupon, i.e., at the end of every coupon period (one quarter), with the first put option date falling on 18 July 2012.

At the next auction, on 25 January, the MoF faces refinancing needs of UAH2.3bn, which is the amount of local-currency debt to be repaid including interest payments during the week, and then at following week\'s auction, on 1 February, it needs UAH1.8bn. The upcoming offering of state debt and the offerings of local-currency bonds from a number of first-tier commercial banks (totalling at least UAH1bn) will be competing for investors\' money. The latter, being wary of this debt with overhang on the MoF, are likely to be more demanding in the auctions of next two weeks, and yields on the primary government bond market are likely to stay put.