Wednesday, 20 November 2013

New Bond may Create Optical Illusion on Yield

Demand for the new benchmark bond is expected to rein in surging yields

The Reserve Bank of India’s decision to sell 10-year government bonds on November 22 will leave the market with a new benchmark security, but that could also be creating an optical illusion as the demand for those bonds could keep the surging yields under check.
RBI is coming out with new benchmark bond to replace the current 10-year 7.16% bond which traded above the 9% yield which many believe is the Lakshman Rekha for the central bank as well as the government.
When a new 10-year bond becomes a benchmark, the yields on it is usually lower by 15 to 20 basis points because of demand. That bond will be sought after since that will be the most liquid bonds. “This is a good strategy to ensure that at least in the public eye the bond yields do not shoot up,’’ said a fund manager who did not want to be identified. “With the current 10-year at 9%, when the new benchmark comes into force, it could be around 8.8% or so for a few months before the security gets widely held.’’
Although governor Raghuram Rajan sounds hawkish, there seems to be a conflicting signal on yields. Interest rates might have been raised twice since he took charge on September 4, but the open market operations, where RBI buys bonds to enhance liquidity in the system, and the new bonds are seen as an attempt to keep a lid on yields.
“Rising yield could be one of the considerations but whenever the basket touches . 70,000 crore, RBI comes out with new benchmark bond,” said Nirakar Pradhan, CIO, Future Generali Life Insurance.
The new bond was traded at 8.69%-8.71% in the when issued market, which is trading before the auction takes place. Whereas the present 10-year benchmark 7.16% closed at 9.01%. It was issued in May. Even the government is worried about the high yields. “No one is comfortable paying higher interest rates,’’ said finance minister P Chidambaram. “How can I be comfortable? We hope that the RBI will take some measures. It is possible that government securities rates will go down. We hope that they will moderate.’’
Investors are getting conflicting signals from the central bank on the possible interest rate increases to contain inflation. Whileconsumer prices rose past 10% for October, prices as measured by the Wholesale Price Index climbed to an eight month high of 7%.
The yield on benchmark 10-year government bonds has surpassed the psychological 9% mark 36 times in the last five years since 2008 and the Reserve Bank of India
    has prevented it from shooting up sharply from that level There will be a burden on the government to pay . 70,000 crore-80,000 crore on the redemption date in 2023.
“One of the reasons the Reserve Bank of India is coming with new benchmark bond could be amount of outstanding stock on 2023 paper which has exceeded . 77,000 crore,” said Harihar Krishnamoorthy, head, treasury, FirstRand Bank. “From ALM point of view, it makes sense for government to spread maturity.”

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