The yield on the 10-year benchmark bond shot up by 10 basis to breach the 8.40% level on Tuesday after the Reserve Bank of India (RBI) surprised the market with a steep 50 basis points (bps) hike in the key policy rate.
These levels were last seen at the end of May this year; indeed the yield on the 10-year benchmark had remained almost unchanged between the central bank?s last policy announcement on June 16. However, taken by surprise the bond markets reacted swiftly on Tuesday; the benchmark five-year overnight index swap (OIS) rate was up 20 basis points at 7.72 % while the one-year rate rose 29 basis points to a record 8.235%.
While treasurers do not expect benchmark yields to harden beyond 8.5%, the higher yields, they point out, will be a cause of concern to the government which is scheduled to borrow R12,000 crore a week in the next three weeks and a total of R79,000 crore by September.
Indeed some of them foresee supportive action from the central bank in the event that yields inch up further. However, given that the central bank has pared its non-food credit growth projection for banks for the current year, the system is not expected to be too short of liquidity.
?It?s possible the finance ministry will come out with supportive statements so that they can borrow at lower rates and would keep yields from hardening beyond 8.5%,? treasurer of a leading bank said.
According to J Moses Harding, head-global markets group, IndusInd Bank, the market was expecting the repo rate to go to 8% only by end-September. ?This was unpleasant surprise and pushed yields to the higher end of the range of 8.25%- 8.40% that we had anticipated for the short term. Till there is more clarity on future hikes, yields should trade between 8.35% and 8.40%,? Harding observed.
Ananth Narayan, South Asia head for fixed income, currency, Standard Chartered Bank, added that with the policy action turning out to be out of syllabus the market will recalibrate its expectations. ?We can expect the RBI?s stance to continue and although the repo rate was not expected to go beyond 8%, that will clearly be looked at now,? he pointed out. Narayan, however, believes that with the credit-deposit ratio improving in favour of liquidity, there would be surpluses available for investments in gilts. ?To that extent we might see the 10-year struggle to go beyond 8.5%,? he observed.
Parthasarathi Mukerjee, president treasury, Axis Bank, too does not see the 10-year yield crossing 8.50%. ?We would see stability coming in at these relatively high levels since the RBI action would result in some slowdown in lending which in turn would have a some impact on inflation,? Mukerjee said, adding yields should trade at 8.30-8.50%. He, however, said that corporate bond spreads might actually contract with more liquidity.
Banks have on average been borrowing around R48,000 crore from the RBI’s liquidity adjustment facility (LAF), which is just about 1% of the banking systems net demand and time liabilities. On Tuesday, banks borrowed a slightly larger amount of R72,710 crore.
According to Harihar Krishnamoorthy, treasurer, FirstRand Bank, the first test for yields is the 8.50% level. ?It is already at 8.39% so another 10-odd bps is possible,? Krishnamurthy said, adding the market will wait to see the increase in base rates before taking action. ?But I don’t see yields flying away beyond 8.50% because it was a flat curve anyway with the10-year yield 8.5% and 91-day yield at 8%. Now the longer end is inching up a little bit.?