Bond yields on swing due to heavy betting by bond investors

Business

oi-Monika Nihalani

By Monika Nihalani

Published: Tuesday, August 16, 2011, 12:42 [IST]

When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons.

The RBI started this rate hiking cycle on March 19, 2010, and has since hiked the repo rate by 325 basis points for the 11 consecutive times. Since inflation did not come down, the interest rates on long-term bonds also remained high.

RBI may continue with its anti-inflationary stance due to high inflation numbers. Though the Index for Industrial Production (IIP) for June 2011 witnessed 8.8%, higher than 5.6% of the previous month, but, IIP numbers are volatile in nature so it is difficult to determine the trend.

Inflation as measured by WPI (wholesale price index) is expected to come in at 9.2% for July 2011 against 9.44% for June 2011. RBI Governor D Subbarao said on Friday, “It is too early to say we will change our stance."

Higher interest rates has resulted into fall in existing bond prices and rise in their yields.

On Friday, yields on the 10-year benchmark government bond headed north, as the RBI indicated it would stick to an anti-inflationary stance.

The US sovereign debt credit rating downgrade by Standard & Poor"s has changed the outlook for global economies, yields of the 10-year bond fell to a three-month low of 8.15% as market participants wagered heavily on the pause in the rate rise cycle earlier last week. But hawkish comments from Reserve Bank of India (RBI) officials on Friday backed with strong industrial production and high food inflation data, sent the yields back to high levels. On Friday, yields closed at 8.30%.

Some investors are on the optimistic stand that the RBI might take a U-turn in short term which led to fall in interest rate swap yields. Five year Overnight Index Swaps (OIS) yields are trading at one-year low of 6.85%, down 160 bps from highs seen in May 2011.

The crisp fall in five year OIS yields suggest that swap traders are betting heavily on growth and inflation coming off, and the Reserve Bank of India (RBI) will be forced to start cutting rates sooner than later.

Government is going to come up with fresh supply of government bonds with lesser trading days this week, which might move yields up again. Bonds worth Rs 10,000 crore are to be auctioned on Thursday.

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