Government bonds to experience high volatility due to MPC's OMO strategy, says Venkatakrishnan Srinivasan of Rockfort Fincap

Srinivasan noted that the MPC kept policy rates unchanged but the unexpected move was the announcement of OMO sales to manage liquidity.

Government bonds are set to be highly volatile in the near future due to open market operation (OMO) announcements in the MPC policy, says Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP. He expects the benchmark yield levels to be between 7.20 percent and 7.45 percent.

In an interview with Moneycontrol, Srinivasan noted that the MPC kept policy rates unchanged but the unexpected move was the announcement of OMO sales to manage liquidity. Edited excerpts:

Why did the bond yields spike after the policy?

The RBI reiterated several times in the previous policy statements that excessive liquidity can pose risks to both price and financial stability. Banks have preferred to place funds under the overnight standing deposit facility (SDF) instead of offering them in the main 14-day variable rate reverse repo (VRRR) operations leading to skewed liquidity distribution in the banking system. Even in today’s VRRR auction, banks have parked only Rs 6,668 crore out of Rs 50,000 crore.

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Hence, the RBI is considering OMO sales to manage liquidity, consistent with the stance of monetary policy. This decision has led the bond market yields to spike immediately. The new 10-year bond has closed at 7.34 percent.

Is the market worried about the tone, was the policy hawkish?

As widely expected, the MPC decided to keep the policy rates unchanged. However, the announcement of OMO sales to manage the liquidity was unexpected.

Have the corporate bond yields spiked as well?

Corporate bond yields too will be affected if the government bond yield spike sustains next week. Primary corporate bond issuers with the highest credit rating may postpone their issuances till the time the bond market becomes stable unless it is already tied up though it may not affect lower credit-rated issuers.

What kind of monthly OMO sales do you expect?

The RBI hasn’t given any specific timeline for OMO sales and said that the timing and quantum of such operations will depend on the evolving liquidity conditions. Market expectations are up to Rs 50,000 crore of OMO sales.

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What kind of liquidity levels do see the RBI would be comfortable with going forward?

The reversal of balance I-CRR funds along with government spending are expected to ease the system liquidity conditions except during festival time. The RBI’s current stance is to maintain adequate liquidity keeping in mind inflationary concerns.

What is your outlook on inflation, will it remain within the RBI band?

Broadly, inflation is expected to soften in the near term with vegetable price correction and a reduction in LPG cylinder prices. However, factors like the El Nino monsoon, demand-supply mismatch in spices, and global energy prices will continue to pose risks to the inflation outlook.

Overall, we expect inflation to be under control as the RBI will continue its stance and make efforts to bring down inflation levels to 4 percent.

What is your outlook on the 10-year government security?

The RBI governor has reiterated that our bond yields are reacting to domestic factors only and not really reacting to international factors. We expect our 10-year government bonds to trade weak and will be extremely volatile in the coming days due to OMO sales auction announcements in the MPC policy. Overall, we expect a broad range between 7.20-7.45 percent levels. Any further spike in US treasury yields will weaken our bond market further.