Mumbai: The bond market rallied on the first full day of trading after the interest rate reductions announced by the Reserve Bank of India (RBI) on Friday. The yield on 10-year government bonds on Monday fell to 4.86%, its lowest level since at least 1998. Bond prices move in the opposite direction of yields. A wave of selling by dealers who sought to cash in on the price rise pushed the yield to 5.17% at the close of the trading day.
Long-term bond yields had risen to a seven-year high of 9.5% in July, but started falling once RBI started cutting policy rates after September to counter a severe liquidity squeeze in the domestic money markets.
The drop in yields on Monday saw investors booking profits with heavy trading in the 10-year segment. About Rs15,000 crore of bonds were traded, with Rs7,105 crore in the 10-year paper alone.
“I think it was an immediate overreaction,” said Anindya Dutta, managing director and head of capital markets, Calyon Bank, of the bond sell-off. “This is typical of this market to overreact a little bit and then retrace.”
Also See Freefall (Graphic)
The fall in yields will help banks boost their treasury pro-fits as they can sell the bonds they own at higher prices.
The rush to buy bonds suggests that banks could be more keen to put their money in government paper rather than lend them to firms, say analysts. The government has been urging banks to lend more to firms in a slowing economy. “The risk perception that corporations might default is still there with banks. Quite naturally, they would like to park their money with RBI or increase their government bond holding and book profit at a falling interest rate scenario,” said Saikiran Pulavarthi, an analyst with Centrum Stock Broking Ltd, adding that banks may increase their bond holdings from the present average of 26-27% even though the RBI requirement is 24% of their deposits.
The drop in yields will also help companies access cheaper loans from the debt market. The yield on 10-year corporate bonds with the highest credit rating followed the same trajectory as treasury bonds, closing at 8.364% from Friday’s close of 8.713%.
Dealers said low yields will also help the government to borrow money from the market at a lower rate of interest. The government will likely announce a higher borrowing programme in fiscal 2010 from its fiscal 2009 programme of Rs1.9 trillion, predicted dealers in the bond markets.
The fall in yields is attributable to last week’s cuts in key rates by RBI, which made its move in conjunction with a fiscal stimulus package by the Union government.
Some dealers, however, said the steep fall in yields is an indicator of more to come, and will help cash-starved corporations in the long run by allowing them to access cheaper credit.
“I believe that yields will continue to come down and will probably hit 4.5% but anything in this market gets exaggerated and it happens faster than you think,” Dutta added.
“The markets are always first to react. Sooner or later, when the rate falls, then it is expected that the banks will start lending to companies which will benefit as they can get funds at cheaper rates,” said Anoop Verma, an associate vice-president at Development Credit Bank Ltd (DCB).
On Friday, RBI cut its key policy rates, the repo and reverse repo, by 100 basis points, while reducing banks’ cash reserve ratio (CRR), or the percentage of their deposits that they keep with RBI, by 50 basis points. One basis point is one-hundredth of a percentage point.
Following the rate cuts, the repo rate, or the rate at which RBI infuses liquidity in the system, stands at 5.5%; and the reverse repo rate, or the rate at which it sucks out liquidity from the system, stands at 4%. CRR is now at 5%.
“People are very long and deep in the money,” said a senior dealer with a primary dealership firm that trades in government bonds, on condition of anonymity. He added that banks invested as much as two-three times their investment target in bonds when yields started falling in the second half of calendar 2008. “On each government bond, traders have now about Rs10 profit. Some of them are selling, some of them are still holding on as yields are expected to fall further,” this dealer said.
The section of the market that is holding on, he said, is doing so on the expectation of further rate cuts by RBI as part of its January policy which would, in turn, push yields further down.
It is this section that is driving the market at the moment, said Verma of DCB. “The yield movement after the rate cuts was expected as the market was not expecting these deep cuts but I don’t think there is another rate cut immediately in sight,” he added.
While some dealers say the yields will fall to the 4.5% level soon, others warn they could climb back to 5.25% as banks start selling to book profits.
“I won’t be surprised if the yields start strong at 5.02% and goes back to below 4.86% and then again climb back to 5.25% tomorrow. This is what is happening in the bond market now as people are inducing volatility in the market,” said the dealer mentioned earlier.