The RBI wants the yield curve to be flatter than it is, with lower long-term bond yields. For this, he is ready to buy long-term bonds in the market. But bond traders see no reason for lower yields, given inflation expectations and the government’s medium-term fiscal path. Add the fact that the ruler ends up borrowing the most at the 8 to 12 year term, known as the belly of the curve, and the market wants a fair price to swallow the supply.
The two sides did not give in. Bond traders bid higher yields for each consecutive bond auction and even for Thursday’s open market operations (OMO) auction, where the central bank was supposed to buy bonds. The RBI responded by refusing to accept the offers. The bond auctions in August saw devolution, while all OMO auctions were turned down. Meanwhile, the RBI has had rebounding operations in which it simultaneously buys and sells government bonds. Behind the twists hides the effort to flatten the yield curve. But the RBI largely failed to do so. In fact, the spread between the 1-year yield and the 10-year yield has only widened in the last six months.
In this stalemate in the RBI market, the loser has been the corporate borrower. “A key question to ask is whether the objective of liquidity measures and trade twists, etc. was reached. This goal was to keep borrowing costs for the private sector benign, ”said R Sivakumar, Head of Fixed Income at Axis Mutual Fund.
Expectations of a pause in rate cuts and new inflation concerns have recently pushed corporate bond yields up 15 to 20 basis points. Granted, yields are still around 100 basis points lower than they were six months ago. But the beginnings of rising yields do not bode well for borrowers. Making it complicated is the preference for blue chip issuers. In addition, the corporate bond market is still illiquid for many securities.
The result is that the RBI’s measures have worked, but not to the fullest extent possible. It takes more steps or a strong message that gives way should be benign. The bond market needs a willing buyer of government securities, not a yield adversary.