Bond Market Insight-Government bond auction results: MoF becomes a net borrower at last this year

Yesterday\'s government bond auction results highlighted the following about the conditions on the primary market for local-currency government bonds as regards both investors and the MoF. First, the auction marked the end of the two-week break in the primary market due to the national holiday that fell on Tuesday, 8 March in a record level of activity.

From the buy-siders, there was UAH4.0bn in total volume of bids submitted in the auction, while the MoF decided to tap the market for UAH3.3bn, selling all the bonds it offered to the market, with the proceeds-to-demand ratio amounting to 83%, up from this year\'s high of 78% seen at the bond auction on 25 January, 2011. In terms of yields, the MoF adhered to its usual tactic of not allowing the yields to move up and down marginally from the levels seen at the recent auctions, in that yesterday, the MoF left the YTMs at similar levels, even despite the possibility of lowering them in the face of a noticeable rise in demand by the investors for the government bonds in UAH. However, the MoF has allowed the YTMs to ease somewhat on the bonds due this September and in January 2014-by 6 and 11 basis points, respectively, to 6.68% and 10.08% YTM, if compared to the auction on 1 March.

The largest volume of demand was garnered by a 3-year bond due in January 2014, totaling UAH1.6bn (a 40.8% share of the total demand volume at the auction). In the end, the MoF raised UAH1.4bn from selling the 3-year bond, or a 41.8% share of yesterday\'s proceeds. Demand for UAH state bonds was firm enough that the average duration of debt raised yesterday by the MoF at the auction was 2.11 years, whereas the last time the MoF sold debt at the auction above such average duration was two years ago, on 19 February, 2009.

The key feature of yesterday\'s auction, in our view, was the fact that the MoF raised local-currency debt of far more size than it needed for this week\'s redemption (totaling UAH1.1bn of principal payback). So in net terms, the MoF is likely to be a net borrower this week, whereas it has been a net redeemer of the state debt year to date until the day before yesterday; as such, the MoF redeemed UAH7.5bn versus UAH6.4bn of auction proceeds. Could this lay the ground for a yields rebound? In our view, the answer is No, because the government, which incidentally just reported UAH7.8bn of funds as being in the state treasury account, appears to be quite confident in holding its status quo. Another strong argument against a hike in yields, in our view, is that the government decided to join with the NBU in its efforts to contain inflation and to withdraw a sizable volume of funds from domestic liquidity levels.