The inversion in the yield curve between Treasury bills and the 10-year benchmark bond is likely to sustain till the time the liquidity conditions in the banking system eases, money market experts said.
Yield inversion happens when the yield on short-term debt instruments trades higher than longer-term ones.
“We may continue to see this inversion till system goes into sustained surplus liquidity mode and the spread between overnight and longer assets increase,” said a senior fund manager who asked not to be named.
However, some experts believe that the spread between the 10-year benchmark bond and Treasury bills to narrow due to expectations of certain inflows in the banking system in March.
According to Gaura SenGupta, economist, IDFC First Bank, systemic liquidity conditions should ease towards the end of March even as government expenditure rises and $5 billion of dollar-rupee sell/buy swap matures on March 11, which will add to the liquidity.
“Hence, by April we expect overnight rates to remain sustainably at the repo rate. This should help ease short-term yields,” Gupta said.
In February, after all rounds of treasury bills auctions, the cut-off yield remained above that of the 10-year benchmark bond.
In the latest auction on February 28, too, the cut-off yield on 182-day and 364-day paper was at 7.1673 percent and 7.1199 percent, respectively. On the other hand, the 10-year benchmark bond was at 7.0668 percent.
“At the current juncture, yield inversion is signalling market demand for long assets. At the longer end, demand is outstripping supply. As market participants want to position for upcoming rate cuts, they have a natural affinity to increase duration,” the senior fund manager cited earlier added.
Also read: MC Explains: All you need to know about yield curve inversion
Why are yield inversion happening?
In the last few months, liquidity in the banking system has remained tight even after support by the Reserve Bank of India (RBI). This pushed short-term rates higher.
On the other hand, the yield on long-term bonds fell sharply on the back of the huge demand seen from domestic as well as foreign investors.
The surge in demand came after JPMorgan announced the inclusion of Indian bonds in its global bond index and the government's lowered market borrowing target for the next financial year.
Currently, the yield on the 10-year benchmark bond is trading at 7.0764 percent, which is sharply lower than that of short-debt instruments.
The yield on commercial papers is trading in the 8.25-8.40 percent range, and certificates of deposits' yield is in the range of 7.65-7.80 percent.
Similarly, the last four auctions of T-bills in February also saw higher cut-off yield on 182-day and 364-day paper compared to the 10-year benchmark.
Also read: India's February manufacturing PMI rises to 56.9, highest in 5 months
Shift in investment
Money market experts are of the view that higher yields on the short-term debt instruments may prompt some domestic investors seeking higher returns to shift their investment.
However, Gupta of IDFC Bank said rate cut expectations will benefit long-term bonds. “Once the rate cut cycle starts, short-term bonds will rally,” he said.
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