NEW DELHI: Traditionally, the 10-year benchmark government paper is the apple of the bond market’s eye. It is the security whose pricing determines value of a wide variety of credit products. It is generally the most liquid bond in the secondary market.
Over the past few months, however, the bond which once occupied the pride of place in bond portfolios, has suffered a fall from grace.
From taking up a lion’s share of daily volumes, the 10-year benchmark bond has recently experienced the ignominy of being transacted only once or twice in the day, that too towards the end of trading.
WHY WAS 10-YEAR RELEGATED?
The paper in question is the 5.85 per cent, 2030 bond, which only two weeks ago ceded its position as the 10-year benchmark bond to the 6.10 per cent, 2031 paper.
It was well before the introduction of the new 10-year, 2031 paper that the 5.85 per cent, 2030 bond had started showing signs of having lost favour as a tradable pick for the market.
The reason behind the unusual phenomenon is clear — RBI‘s single-minded focus over the last year to keep yield on the 10-year benchmark bond anchored around the 6.00 per cent mark.
In its quest to do so, the central bank has amassed vast quantities of the 5.85 per cent, 2030 bond through a combination of outright open market purchases, special open market operations as well as through secondary market interventions.
Sure enough, from RBI’s perspective, the strategy worked. Over the last financial year and much of this one, yield on the 10-year benchmark bond has largely hovered around 6 per cent despite a surge in inflation, a huge supply of sovereign debt and deteriorating government finances.
RBI cannot exactly be blamed for its endeavours, as it was essential to keep a lid on the borrowing costs amid the economic crisis unleashed by the coronavirus. Perhaps, the central bank’s expectation was that by keeping the 10-year point of the yield curve depressed, other points in the curve would follow suit.
Things have not turned out that way.
After its large-scale bond shopping, RBI is said to be holding around Rs 80,000 crore of the Rs 1.2 lakh crore outstanding amount on the 5.85 per cent, 2030 bond.
Essentially this implies that the floating stock — or the tradable quantity of the bond in the secondary market — was negligible. Moreover, it would be very difficult for traders to take a short position, or bet against the bond if conditions warrant a rise in yields.
Left with few opportunities to express a realistic view on interest rates and the government’s fiscal position, market participants took to concentrating their activity in two other bonds — the 5-year benchmark 5.63 per cent, 2026 bond and the 14-year, 6.64 per cent, 2035 bond.
Yield on the 6.64 per cent, 2035 bond is currently 60 basis points above that on the 10-year benchmark paper, a wider gap than what used to typically exist between papers of such similar maturity.
“Essentially, in some of the recent discussions between some RBI officials and the market, there was some concern about what happened to the old 10-year bond and spreads with other papers,” a senior treasury official with a foreign bank said on condition of anonymity.
“The 5.85 per cent, 2030 bond has completely stopped trading and even the new 10-year paper is lagging behind the 5-year bond and the 14-year bond. There is absolutely no interest in the 10-year bond. It seems after the last auction that RBI does not want the 10-year to become a dead paper again, perhaps they will be a little more tolerant of yield drifting up rather than putting so much of the bond in their own book,” he said.
NEW APPROACH FOR NEW 10-YEAR
On July 9, when RBI conducted the maiden auction of the new 10-year bond, the central bank may have provided a signal that the 6 per cent handle of the last year was now a thing of the past.
At 6.10 per cent, the coupon on the new 10-year 2031 bond seemed to be a more realistic pricing, given the supply-inflation metrics, bond dealers said.
The coupon may have been even higher if not for some probable nudging from the RBI, but it seems clear that the central bank’s target range has now been revised upward. The RBI does not publicly state its desired level for bond yields.
It was at last week’s auction on Friday, however, that the market got a clearer glimpse of where the central bank may let the benchmark yield drift up to.
In what was only the second auction of the new 10-year bond, the RBI devolved a whopping 11,144 crore rupees worth of the 6.10 per cent, 2031 bond on primary dealers out of the 14,000 crore rupees of the bond that was up for sale.
The cutoff yield that the RBI set was 6.15 per cent. Yield on the bond has drifted higher today and was last at 6.17 per cent.
Moreover, the bid-cover ratio, a key metric of demand at auctions, was less than 2 times, implying a lack of interest among investors. The bid-cover ratio is derived by dividing the total number of competitive bids received by the notified amount. Generally, a bid-cover of 3 times or more is considered to be a sign of a well-bid auction.
While the devolvement at 6.15 per cent essentially means that the RBI is not comfortable with yield on the 6.10 per cent, 2031 bond hardening even further, the shift in the central bank’s approach is clear.
Unless RBI includes the 6.10 per cent, 2031 paper in its next few rounds of open market operations, some traders see the yield on the paper rising to as much as 6.20 per cent.
In the previous year, whenever yield on the 10-year benchmark bond rose beyond RBI’s desired range, the central bank immediately took ameliorative measures — either by announcing dispensations such as increased room in HTM portfolios or through a gamut of open market interventions.