From surging to multi-year highs following the Reserve Bank of India’s surprise rate hike on May 4, sovereign bond yields have cooled off significantly, with many attributing the renewed buying interest to hope of the central bank stepping in to support the market. Bond prices and yields move inversely.
In the three trading days following the rate hike and the RBI’s warnings on upside inflation risks, yield on the 10-year benchmark government bond jumped more than 30 basis points to a three-year high of 7.46 per cent.
And just as suddenly, in the next trading week from May 9-13, yield on the 10-year paper plummeted 24 basis points to a low of 7.22 per cent; almost as if the RBI hadn’t just taken a decisive turn towards tighter monetary policy.
Dealers broadly attributed the wild swings to one theme – the government’s seeming displeasure with the sharp rise in its borrowing costs and the possibility of its debt manager, the RBI, stepping in to manage the situation.
News reports in the week after the RBI’s rate hike said that the government was displeased with the way in which yields had shot up and that it had requested its debt manager to consider steps such as bond purchases to bring yields down.
Separate reports said that the RBI was open to supporting the bond market.
With the interest rate cycle turning amid huge bond supply pressures – the government is slated to sell a record-high Rs 14.35 lakh crore worth of bonds in FY23 – strong buying support from the RBI would go a long way in helping the market.
Moreover, over the last couple of years, the RBI has maintained a strong grip on sovereign borrowing costs, stepping in aggressively whenever yields rose beyond a point and referring to the bond yield curve as a public good.
No doubt, these were the considerations playing on the minds of bond traders when yields came tumbling down.
Subsequent developments, however, poured cold water on the market’s hopes.
Not only did the RBI not announce any open market purchases of bonds, data showed that the central bank had actually sold small quantities of government paper.
In the two weeks ended May 6, the RBI has cumulatively sold Rs 2,455 crore worth of government securities, data on the central bank’s website showed. The data is released with a lag.
One cannot blame the central bank for its actions as it is after all looking to reduce the massive liquidity surplus in the banking system amid hardening inflation risks.
Sales of government bonds mop up excess liquidity, while purchases of bonds have the opposite effect – addition of durable liquidity.
The RBI does have other tools in its arsenal to aid the bond market – it could again increase the room for banks to park government bonds in a trading portfolio that is immune from marked-to-market losses.
The action in the bond market, however, clearly suggests that when it comes to liquidity, the RBI is unwilling to carry out actions that are not in consonance with its aim to control inflation.
“For now, the market seems to have made its peace with the direction of yields, there is also buying support that has emerged around 7.38-7.40 per cent yield on the 10-year bond,”
Primary Dealership Head of Trading Naveen Singh told ETMarkets.
“Interest rates will go up much further from here because it will take a long time for inflation to come down from 6-6.5 per cent levels. That makes it very difficult for RBI to step in to support the market in the form of bond purchases the way it has for the last couple of years,” he said.