Bond yields held artificially low
In the last government bond auction conducted on the 22nd of January 2021, the bond market clearly showed its reluctance to bid for bonds at current levels of yields. The 5-year benchmark bond saw the RBI devolving the full auction on to the underwriters, as bids were well above 5.3% levels, almost 40bps higher from lows seen a few months ago. RBI also did not accept any bids for the 10-year benchmark bond, as the market bid at higher levels.
5&10 year G-Sec Auction result-
| 5.15% GS 2025 | 5.85% GS 2030 |
Notified Amount (Rs billion) | 110 | 80 |
Cut off Price | 99.32 | NA |
Implicit Yield at cut-off (%) | 5.3107 | NA |
Amount accepted in the auctions (Rs billion) | 2.5 | NIL |
Devolvement on Primary Dealer (Rs billion) | 107.5 | NIL |
Nervous bond market
The bond market is clearly nervous on absorbing bond supply at these levels of yields. The union budget for fiscal 2021-22 is coming up next week and it will be a spend budget, largely financed by borrowing. The budget is inflationary in nature as it is targeted to push up economic growth.
While bond traders shun the yields, the buy and hold investors such as banks, insurance companies and provident funds are forced to buy bonds at levels that the market does not want and this increases the risk in their portfolios.
Why is it a moral hazard?
RBI is supporting the government fiscal deficit by its actions of holding a tight rein on the market. The central bank is now becoming the market and is not allowing the market to function normally. This leads to a huge mispricing of risk across the system from corporate bonds to equity markets. Typically when risk is mispriced, blowouts are severe as seen in 2008 financial crisis.
Government bonds, SDL and OIS yield movements.
During the week, 5.85% 2030 yield came down by 4 bps to 5.91%, 5.77% 2030 yield decreased by 5 bps to 5.94% while 5.79% 2030 bond yield rose by 2 bps to 5.97%. 5-year benchmark bond, 5.22% 2025, yield lost 2 bps to 5.22%. Long term paper 7.16% 2050 yield came down by 3 bps to 6.51%.
The spread of 10-year bond over 5-year bond (5.22% 2025) declined to 69 bps from 71 bps from previous week. On the other hand, 15-year benchmark over 10-year benchmark spread rose to 42 bps from 36 bps while 30-year benchmark over 10-year benchmark spread rose to 73 bps from 62 bps.
In the SDL auction conducted last week, average 10-year SDL yield rose marginally to 6.62% from 6.61% last week. The spread with G-sec benchmark came down to 65 bps from 69 bps.
On weekly basis, 1-year OIS yield came down by 4 bps to 3.76% while 5-year OIS yield increased by 1 bps to 4.76%.
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