InvestorQ : What is the meaning of the bond yields going up so sharply? Does it mean that RBI is going to increase interest rates?
prachi Patwardhan made post

What is the meaning of the bond yields going up so sharply? Does it mean that RBI is going to increase interest rates?

sara Kunju answered.
2 years ago

On Wednesday, the 10-year bond yields in India touched 6.50% and closed the day at 6.49%. This is the highest level of bond yield since April 2020. That means we have not seen such high yields in the last 20 months. In the bond market context, there are a number of reasons for the spike in bond yields. Let me encapsulate some of them.

a) RBI is not issuing any new 10-year bond, which is rather strange because the outstanding stock of bonds currently is close to Rs.1.48 trillion and the RBI normally issues new 10-year bonds when the stock gets close to Rs.1.50 trillion.

b) That keeps the markets guessing as they believe that the RBI may look at higher yields for its next bond issue. However, most investors continue to be skeptical of the government bonds as if rates go up then returns may fall sharply.

c) In the last few auctions of bonds, there has been continuous devolvement on RBI. RBI does not want to offer higher yields and at the current yields, there are no takers among the banks and institutions. That led to bond yields to being pushed up to near the 6.5% mark. Markets bet that the RBI cannot afford devolutions beyond a point.

d) As part of its open market operations or OMO, the RBI has been selling bonds quite aggressively each week to suck out the excess liquidity in the system. That means, as bonds get sold aggressively, the excess supply pushes the price of bonds down. Now, since the yields are inversely related to the prices, the bond yields are moving higher.

e) One important factor is the variable-rate reverse repos (VRRR) done by the RBI to soak liquidity in short-term debt paper. Since the yield curve is upward sloping by default, any spike in short-term yields automatically gets transmitted to the longer end, and this has also pushed up yields on the 10-year benchmark bonds.

f) One thing we cannot ignore is inflation. The US does not call inflation transitory any longer. For November 2021, the retail inflation stayed just below the 5% mark at 4.91% but wholesale inflation or producer inflation was elevated at 14.23%. This has raised concerns that the RBI may choose to hike rates sooner rather than later.

g) Finally, look at the US, which is planning to complete the taper by March 2022 and start hiking rates immediately after that. The RBI December monetary policy was under the cloud of Omicron. However, the bond yields are building in hawkishness by the RBI expecting that the RBI may surprise with a rate hike in February.