The yield on the benchmark government bond continued to rise on July 6 amid worries around higher crude prices feeding into inflation. The current phase of transition from the old benchmark to the new one also caused the former to turn illiquid and investors to exit it, market participants said.
The benchmark bond yield closed at 6.175 percent, up from the previous close of 6.088 percent. Every year, the Reserve Bank of India (RBI) notifies a new 10-year government security as the benchmark bond. According to market players, the new benchmark bond auction is expected on 9 July.
“There are two specific events which have happened today which have led to this kind of reaction in the market. The first is that the oil prices have gone close to $78, which is almost a 10 percent increase from the $70 level which the market was comfortable with,” said Mahendra Kumar Jajoo, Chief Investment Officer -- Fixed Income, Mirae Asset Investment Managers (India).
The second event is that the RBI has announced the first leg of the government securities acquisition programme for the second quarter and for the first time, they have not included any of the active benchmark securities, Jajoo said. “All the securities are old ones, which are not currently being issued. Therefore, the supply in the market will suddenly increase.That’s why the market is feeling a little jittery and the yields have gone up,” Jajoo said.
On 5 July, the RBI announced the list of securities worth Rs 20,000 crore it will buy under the G-sec Acquisition Programme (G-SAP 2.0) on 8 July.
Therefore, the spike in yields can be explained partly by technical factors. “The yield has shot up on the current benchmark because the RBI has decided to introduce a new 10-year benchmark bond auction this weekend,” said Ajay Manglunia, Managing Director and Head of Institutional Fixed Income, JM Financial.
The 5.85% GOI 2030 paper, which was the benchmark so far, is now trading at 6.16-6.18 percent levels. Manglunia said that this is not an exception because all old benchmarks are trading at higher yields. “After this is phased out, the new benchmark is likely to settle at 6-6.05 percent yield. So people are trying to get out of the old benchmark so as to have room to accommodate the new paper,” Manglunia added.
However, macroeconomic fundamentals are also playing a part, with consumer inflation hitting a six-month high of 6.3 percent in May. The rising price of crude only darkens the outlook for inflation and that could create problems for the RBI, which has been trying to keep yields low to encourage growth. In several bond auctions conducted over the last few months, the RBI has chosen to devolve bonds on primary dealers and underwriters when it felt that the yields being quoted were too high.
“It’s not just illiquidity. We also need to look at the overall trajectory and underlying fundamentals. All the fundamentals are now saying that yields are headed upwards,” said Soumyajit Niyogi, Associate Director, India Ratings and Research. To a certain extent, yields were controlled by the RBI, which was trying to ensure a balance between the cost of borrowing and the growth rate. “But, whenever there is an opportunity, the yield is trying to align with reality,” Niyogi added.
Niyogi pointed out that the last time the price of Brent was at $80, the bond yield was much higher. So the market is factoring in oil prices and global bond prices, which have also hardened from last year’s levels. “My sense is that the RBI will not allow yields to shoot up sharply, but holding them at six percent by whatever means required is not judicious too in sync with the inflation,” Niyogi said. He expects the benchmark yield to move in the 6.12-6.25% range.
Mirae’s Jajoo agreed that yields are unlikely to remain anchored close to the six percent mark here on. “From what is happening right now in the oil market and inflation, it looks a little difficult that yields will remain around six percent. The RBI was trying to keep yields at a comfortable level. When the ground realities change, the RBI will also change its outlook,” Jajoo said.
In its June policy meeting, the monetary policy committee (MPC) had reiterated its commitment to keep the policy stance accommodative for as long as required. In the August policy meeting, scheduled for 4-6 August, the MPC is widely expected to keep the repo rate unchanged at four percent and maintain its accommodative stance.
Thereafter, in October, a more cautious assessment may be in order, experts said. “In the October policy, the RBI will have the first quarter company results and a much better understanding of the Covid scene and that policy meeting will be very critical,” Niyogi said.
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