Fed rate cuts have little impact on bond yields

Fed rate cuts have little impact on bond yields
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First Published: Wed, Dec 12 2007. 11 24 PM IST

Cut policy: Bond dealers do not see any impact of the latest Fed rate cut and do not expect the Reserve Bank of India to reduce its policy rate. Photo: Harikrishna Katragadda / Mint
Cut policy: Bond dealers do not see any impact of the latest Fed rate cut and do not expect the Reserve Bank of India to reduce its policy rate. Photo: Harikrishna Katragadda / Mint
Updated: Wed, Dec 12 2007. 11 24 PM IST
Mumbai: Despite a 25 basis points cut in the Federal funds rate on Tuesday—the third rate cut since September, the Indian government bond yields remained virtually unmoved.
The yield on the 10-year benchmark bond closed at 7.88% on Wednesday, unchanged from the Tuesday’s level.
The three-stage rate cut since September has brought down the Fed funds rate to 4.25%, from 5.25%. Following the latest cut, US government bonds rose the most in more than three years. The yield on benchmark 10-year notes declined almost 19 basis points to 3.97%—the biggest drop since 15 June 2004 in the US, according to Bloomberg.
One basis point is one hundredth of a percentage point.
Cut policy: Bond dealers do not see any impact of the latest Fed rate cut and do not expect the Reserve Bank of India to reduce its policy rate. Photo: Harikrishna Katragadda / Mint
While there is no impact of the rate cut on the 10-year benchmark bond in India, a small rally has been taking place in the longer-end of the yield curve. However, according to dealers, this is independent of the Fed rate cut. “Heavy purchases made by the insurance, pension and provident funds are triggering the rally for the long dated paper,” said a bond dealer with a primary dealer who buys and and sells government bonds.
The yield on the benchmark 10-year bond was 7.89% in the first week of September before the first round of rate cut by the US Fed. On Wednesday, it was 7.88%.
Bond prices and yield move in opposite directions.
The yield on long-term bonds, however, dropped by 8-10 basis points. For instance, a 20-year paper, maturing in 2036, was trading at 8.35% on 30 November. Now, its yield has dropped to 8.27%. The widely traded 2022 paper, which now has a yield of 8.06% was trading at 8.14% in the last week of November.
Another popular bond with long-term investors, maturing in 2022, has also seen its yield drop by 9 basis points. Their prices are rising as long-term investors, such as pension and provident funds, are chasing these papers. “In some cases banks are also buying bonds with a slight slowdown in credit disbursements,” said the treasury head of a foreign bank who does not wish to named.
“After the CRR (cash reserve ratio) hike by the Reserve Bank of India (RBI), all the major negatives were factored into the yield curve,” said Vijay Anand, associate vice-president of Development Credit Bank Ltd. “At the long end of the yield curve, there were some papers that were not so liquid and because of this the yields on these papers were on the higher side.”
RBI reissued Rs5,000 crore of its 8.20% 2022 bonds and Rs3,000 crore of its 8.33% 2036 bonds in November. The increased supply boosted the trading of these bonds in the market. Dealers said there is a need to correct the long-term paper yield because there is a wide gap between the 10-year paper and longer-term bonds’ yields.
While the yield on long- term papers were veering around 8.19-8.20%, the 10-year paper yield did not rise beyond 7.94% in recent times.
Of late, the 25 basis points yield differential has substantially narrowed following the drop in the yields on long-term papers. Bond dealers do not see any impact of Fed rate cut and do not expect RBI to cut its policy rate.
“The market has not moved on the Fed rate cut,” said Aloke Prasad, assistant general manager of Securities Trading Corporation of India Ltd, a non-banking finance company. “At the most, we can say that there has been a 2-3 basis points movement in yield on rate cut expectations.”
According to A. Prasanna, vice-president, ICICI Securities Primary Dealership Ltd, the Fed cut was more or less anticipated and factored in the bond market.
“It would have been a surprise had there been a 50 basis points cut,” said Prasanna.
He said the bond yields are range-bound currently because of the tight liquidity condition prevailing in the money market.
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First Published: Wed, Dec 12 2007. 11 24 PM IST