The bond market was mired in the longest slump since 1998, one that has stretched for more than six months, according to Bloomberg. That ended on Tuesday, as sentiment took an about-turn to begin an impressive rally.

Bond yields dropped 25 basis points, the biggest single-day fall that even the deluge of demonetization in 2016 couldn’t take credit for. The benchmark 10-year bond is now around 7.37% and trade volumes have jumped. It seems all the government had to do to escape higher cost of borrowing was nod to everything that the bond market wanted.

So for the first time in a decade, the government will borrow only 48% of its full-year borrowing in the first six months. It will issue floating rate bonds, and borrow more through short-term bonds, thereby making it easier for investors to manage treasury.

Voila, public sector banks which had forsaken the bond market are now back, sparking up trade volume. They will be the biggest beneficiaries of the rally. Many of these lenders will narrowly escape the prospects of big losses due to the mark-to-market hit on their bond portfolio given the dive yields took on Monday.

The obvious question is: how sturdy are the legs of this rally?

Investors are expecting the 10-year bond yield to drop by 10-15 basis points more to trade around 7.25% in the next three months. What will aid this is the fact that liquidity is likely to remain mostly in surplus mode, making it easier for banks to absorb more of the borrowing. Since the first two quarters do not see a rush for private credit offtake, there will be enough appetite from banks.

Another factor is that during the first quarter, the maturity of past issuances is high, making the net borrowing of the government lower than in the comparative period of previous years.

So what can trip up the bond market?

It is not that the government is borrowing less than the budgeted Rs6.06 trillion. In the run-up to an election year, it is futile to expect the government to prune its spending. Therefore, the government has simply postponed the bulk of its borrowing to the second half of the fiscal year.

Historically, the final six months of a year are what is termed as a busy season for private credit. Private companies tend to borrow the maximum during this time and even state governments borrow more. Analysts are foreseeing a bunching up of bond supply and therefore a surge in yields.

Yes, the legs of the rally are sturdy enough to last for at least two quarters. But all the government’s move does is kick the can of worms a bit further down the road.

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