Curve steepens as bond yields hit 14-month high

By: |
Mumbai | November 17, 2017 4:35 AM

The benchmark Bond yield hit a fresh 14-month high on Thursday having closed at 7.06% even as the markets continued to factor in worries about fiscal slippage, rising inflation and dampening expectations of a rate cut going forward.

This has led to a steepening of the yield curve where-in long tenor yields have risen much more than short-tenor yields. (Image: Reuters)

The benchmark Bond yield hit a fresh 14-month high on Thursday having closed at 7.06% even as the markets continued to factor in worries about fiscal slippage, rising inflation and dampening expectations of a rate cut going forward. This has led to a steepening of the yield curve where-in long tenor yields have risen much more than short-tenor yields. The benchmark yield for instance has risen by 36 basis points since the last monetary policy on October 4. Compared to this, short-tenor yields have not seen much movement. For example, yields on three-month paper have risen by just three basis points in the same period. The yield curve tends to steepen when the market expects the interest rates to either rise or not fall from current levels. The reverse happens when the market starts anticipating a fall in interest rates in the near term—a phenomenon seen in July this year when a low CPI inflation for the month of June triggered rate cut expectations. As Shubhada Rao, chief economist and group president at Yes Bank points out, a lot of factors have converged leading to a rise in yields.

“Oil prices have risen in recent times where as US bond yields have also hardened. Along with this, we have worries over fiscal slippages coupled with the lack of clarity yet on recapitalisation bonds. However, we believe there is room for some retracement from current levels as it seems to have factored-in all the persisting worries,” Rao observes. With oil prices continuing to trend above the $60 mark, market participants consider inflation as a major cause of concern. Consumer price index (CPI) inflation for October stood at 3.58% compared to 3.28% in September and expectations that inflation would remain at elevated levels has led to a dampening of rate cut expectations.

This is clearly reflected in the overnight indexed swap (OIS) rates. OIS are derivate instruments used to hedge interest rate exposures. The five-year OIS stood at 6.55% on Thursday which is the highest since May 31 where as the one-year OIS stood at 6.29% which is the highest since June 8 this year. Even non-deliverable OIS rates have shot up. As Ajay Manglunia, EVP at Edelweiss Securities states there is a lot of pessimism built in the market. “There is anticipation of a fiscal slippage even as most of the planned government borrowing will be finished by December-January. Moreover, rising oil prices and domestic inflation has left very little room for another rate cut. These factors have pushed the yields higher leading to steepening of the curve,” Manglunia said.

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