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Bond yields may start rising soon

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Indian bonds could be set for a correction, amid a steady rise in global bond yields and the recent steep rally in Indian bonds, even as there could be scope for a small rate cut by the Reserve Bank of India ( RBI), say bond traders.
The bond market has rallied quite sharply in the past few months and there is limited room for yields to fall now. Yields fall as prices rise.
The 10- year bond yield was at around 7.9 per cent level in February. Now, the cut- off in the new 10- year bond is at 6.9 per cent, indicating bond yields have fallen a full percentage point in the past few months.
The yields on the 10- year bond closed at 7.05 per cent on Friday. According to India Ratings & Research ( Ind- Ra), the rate cycle could soon turn.
“Inflation has bottomed out, leaving the RBI with less room to undertake further rate cuts,” said the rating agency.
“Ind- Ra believes that in such a scenario, companies may lock in their long- term funding at the current rates, before the cycle turns,” it said in its report on Thursday.
The reason for the bull run in domestic bonds was the change in liquidity stance by the central bank and continued secondary market purchase of bonds that infused so much liquidity in the banking system that it went from liquidity deficit to surplus mode.
But that stimulus is unlikely to aid bonds much, Ind- Ra added.
After remaining in the negative zone, global bond yields have also started rising.
The US treasury yields traded at their highest since June, while the Japanese 30- bond yields rose sharply this week. German ‘ bunds’, after remaining in the negative territory for an extended period, also turned positive, as expectations of a US Fed rate hike took hold.
This will have its impact on local bond yields as well. However, not all share that logic. “ When global bond yields were falling, our yields were rising. So, there is no reason to believe we will follow global yields this time,” said Devendra Dash, senior bond trader at DCB Bank.
However, according to a senior bond trader with a foreign bank, bond yields should fall now, as the “fundamentals have started vanishing”, with drop in industrial production and expectations that inflation could rise in the coming months, once the base effect wears off.
Surely, a tell- tale sign of an impending correction, albeit not avery sharp one, shows in the overnight index swap (OIS), which is used to hedge bond investment.
It is a floating rate, used to swap with fixed- rate bonds.
The five- year OIS is now at 6.39 per cent, whereas the policy rate ( considered an overnight rate) is 6.50 per cent. The one- year OIS is about 6.47 per cent. This means that a segment of the market does not expect rates to fall much.
Business Standard New Delhi,17th September 2016

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