The weak demand-supply dynamics continue to weigh on the government securities market, keeping yields still elevated. The weak demand from banks, insurance companies and pension funds cannot match the constant supply, said market participants. This has led participants to bid at higher yields in the previous auction, followed by which the Reserve Bank of India (RBI) rejected bids. Traders expect higher cut-off yield in the auction, which will be held on Friday.
“As majority of the rate cut is behind us, the support from rate cut cycle to the bond market is over. Yields are still elevated due to continuous supply where demand is not so strong,” said Gaura Sengupta, chief economist, IDFC FIRST Bank. She added that demand has not picked from real investors on account of lower inflows for insurance companies and higher equity allocations by pension funds.
The RBI cancelled the auction for the seven-year government bonds worth Rs 11,000 crore on last Friday as participants bid at 6.60%, a level at which 10-year bond was trading that day. Rejection of bids signals that the RBI is uncomfortable at yield breaching 6.60%, said market participants.
In Friday’s auction, the RBI planned to sell bonds worth Rs 32,000 crore, which includes new 10-year bond. Market participants expect the cut-off yields to be higher. “Due to overall less demand, I expect cut-off yields to come at 2-3 basis points higher than market levels. As most banks are sitting on mark-to-market (MTM) losses, they are not really coming in right now to buy. Effectively, market depth and market liquidity has reduced,” said a treasury head at a foreign bank.
The yields rose 27 bps since June policy, when RBI shifted the stance to ‘neutral’ from ‘accommodative’. subsequently, fiscal worries pushed up yields further. Though yields have come down from its peak, it is still high considering RBI’s 100-bps rate cut. Though government has reduced the supply in the longer-end, the relief from that did not sustain for long. The yield on 10-year benchmark bond ended 6.52% on Thursday. There was also a speculation of RBI buying bonds in the market, which slightly eased yields by 2 bps on Thursday.
The concerns over higher yield led RBI to hold discussion with market participants in the week. In a recent interaction between RBI and primary dealers, market participants asked for bond purchases through open market operations (OMO) to infuse liquidity and protect yields.
The regulatory changes in the investment portfolio has led to weaker demand from banks. “Banks continue to maintain comfortable SLR (statutory liquidity ratio) holdings, and with RBI’s new investment norms for daily mark-to-market valuation on HFT (held-for-trading) portfolios, trading desks remain cautious in taking large positions,” said V R C Reddy, head of treasury, Karur Vysya Bank. “Post-Fed’s hawkish policy, uncertainty persists regarding the timing of a potential rate cut in December,” he added.
A chief dealer at a state-owned bank said, “High festival-related CIC (currency in circulation) leakage and sluggish deposit growth, coupled with strong credit expansion, have widened the deposit-credit gap and pressured banks’ margins. With limited surplus funds, banks are meeting needs by liquidating holdings, reducing investment demand.”
Going ahead, market participants the bonds to trade in a range. “I expect 10-year benchmark yield to trade between 6.35% and 6.50% in the near-term. However, 6.35% will come into play only if RBI announces OMO,” said Sengupta.
According to Reddy, “The 6.60% yield level on benchmark government securities continues to act as a strong resistance. The RBI’s recent decision to reject bids at the last auction underscores its discomfort with elevated yield levels, despite the prevailing easy monetary conditions.”