New 10-year bond at 6.1% signals RBI's tolerance for higher yields

Illustration by Binay Sinha
The Reserve Bank of India (RBI) issued a new 10-year bond on Friday and set the coupon at 6.10 per cent, higher than what most of the market was expecting. This indicates the RBI’s willingness to start accommodating the market demand for higher yields in the face of rising inflation after it spent months trying to cap the yield at 6 per cent.

The market was expecting the RBI to keep the cut-off at around 6 per cent, going by precedents, or allow up to 6.05 per cent. The coupon on the last 10-year benchmark bond, issued in December, was 5.85 per cent. 

Yields firmed up earlier this week as the bond market geared up for another round of tussle with the RBI ahead of Friday’s 10-year bond issue. The market was signalling that the cut-off has to be higher for it to participate properly in the auction.

However, bonds rallied after US yields dropped and the RBI governor assured of continuation of accommodative policies for long. With this, the cut-off expectations also tapered.

The cut-off is much higher than the 6 per cent that the RBI had implicitly wanted the earlier 10-year secondary market yields at.  

“Given the supply and higher inflation, the RBI has accepted that lower rates are not feasible,” said Debendra Dash, senior vice-president at AU SFB. 

Against the Rs 14,000-crore auction planned for the new 10-year paper, bids for Rs 28,428 crore of bonds were received. The new 10-year was part of the Rs 26,000-crore auction planned on Friday.  There was no devolvement in this auction.  

Bond dealers say this would help correct the distortion in the yield curve. The 10-year yield was suppressed for a long time whereas other maturities moved up.

As a result, the market was creating its own methodologies to arrive at a blended yield for the 10-year bond. Because the RBI aggressively picked up the last 10-year bonds, the secondary market trading also thinned in the most important benchmark for the economy. The 10-year bond was the sixth most traded in the market. It should ideally be the most traded.  

“The RBI will most likely allow interest rates to adjust upwards slowly given the uncertainty of Covid infections,” said Dash. However, if there is a third wave, then the yields could even readjust back to lower levels, he said. 

RBI Governor Shaktikanta Das told Business Standard on Wednesday that the central bank is focused on all the maturities, and not just the 10-year. But the 10-year has a greater influence on the entire yield curve and that explains the RBI action of intervening in that segment disproportionately in a bigger manner.  

Bond yields rose a few basis points after the auction results came. The most traded bond maturing in 2035 closed at 6.76 per cent, from its previous close of 6.73 per cent. Similarly, the benchmark 5-year paper closed at 5.73 per cent, from its Thursday’s close of 5.70 per cent. 

The two-way movement of the yields in the last few days can be attributed to the uncertainties surrounding the market. 

“Markets will remain edgy on both sides as they grapple with the recovery and inflation headwinds. Structurally, if we don’t see headwinds on opening up due to any virus resurgence, we will look at continued higher inflation and possible taper down the lane that will keep fixed income markets at tender hooks,” said Ashhish Vaidya, head of treasury at DBS Bank.

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