Floating Rate Bond yields rise as RBI increases supply

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November 03, 2021 3:30 AM

Additionally, in the past few months, spread over Treasury Bills (T-Bills) available on FRBs remained compressed, considering the rate cycle and risk associated with it. The compression in spread handled smart price appreciation to its holder.

Market participants said investors are not buying these papers because returns on fixed-term papers are higher on a daily basis. However, duration risk on floater bonds is lower than fixed-rate bonds.Market participants said investors are not buying these papers because returns on fixed-term papers are higher on a daily basis. However, duration risk on floater bonds is lower than fixed-rate bonds.

Yields on Floating Rate Bonds (FRBs) have risen over the past few days, and are currently trading in a thin band as investors refrained from buying these bonds after the central bank increased the supply of long-end FRBs with an eye to lower cost, even as other fixed maturities papers attract higher yields on a daily basis.

Additionally, in the past few months, spread over Treasury Bills (T-Bills) available on FRBs remained compressed, considering the rate cycle and risk associated with it. The compression in spread handled smart price appreciation to its holder.

On Tuesday, the yield on FRB 2028 closed at 4.4202%, FRB 2034 at 4.7423%, and FRB 2033 at 4.7955%. All FRB bond yields were 2-3 basis points higher than the previous close. “The government has increased the supply of FRBs, thus the scarcity premium should also fall going forward. From the government’s perspective, it makes sense to issue more of long-tenure FRBs. This way they can extend the maturity with lower interest cost,” said Pankaj Pathak, fund manager, fixed income at Quantum Asset Management.

Market participants said investors are not buying these papers because returns on fixed-term papers are higher on a daily basis. However, duration risk on floater bonds is lower than fixed-rate bonds.

“It is possible that even the peak effective yield for the floating rate bond (at least over the foreseeable forecast horizon) isn’t much higher than what the equivalent maturity fixed rate bond is already offering on a daily basis,” said Suyash Choudhary, head – fixed income, IDFC Mutual Fund.

The Reserve Bank of India, as per the indicative borrowing calendar, is expected to sell FRBs worth Rs 32,000 crore till March. Currently, the central bank is offering FRBs on weekly bond auctions every fortnight. On October 1, the central bank sold new FRB 2028 at a cut-off yield of 4.0400%, and currently, it is trading at 4.4202%, with just five trades taking place till the closing of the market.

This was even after the yields on the T-Bill rose to an 18-month high last week. Usually, in a rising interest rate scenario, investors buy FRB to avail better returns because the yields on these papers are linked to T-Bills. The FRB bonds carry a coupon with a base rate equivalent to a weighted average yield of the last three auctions of 182-day T-Bills plus a fixed spread decided by way of auction.

Dealers with state-owned banks expect volumes in the FRB segment to increase after the December policy, where a hike in reverse repo rate is expected. Most short-term money market rates have already adjusted 30-40 basis points higher on this anticipation.

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