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B. Venkatesh

Bond yields dipped marginally (2 to 3 bps) week-on-week. The 10-year bond currently trades at 5.76 per cent YTM. Going forward, bonds are likely to remain range-bound. The cut-off yields at the forthcoming auction will set the trading range for the week.

On July 10, the RBI received just over Rs 31,000 crore at the one-day repo. This suggests that liquidity in the system is still comfortable. Unless the RBI conducts OMOs and sterilizes excess liquidity in the system, bonds will continue to remain biddish.

Of course, certain other factors prevent dealers from aggressively bidding up bond prices. Term spreads, for instance. The long-term spread is currently 34 bps, while the short-term spread is 67 bps; the spreads are lower by 4-6 bps compared with the previous week.

The yield curve is, thus, highly concave. If dealers aggressively bid up prices, the portfolio risk on the trading book will increase further. This is because long-term bonds will carry lesser convexity gains on the upside. Further, the high premium to face value at which these bonds trade will provide lesser protection on the downside when yields rise.

In any case, there seems no compelling reason other than excess liquidity for dealers to bid up bond prices. The RBI has stated that it is unlikely to cut the repo rate now, perhaps, because of concerns about inflation. The central bank, however, continues to adopt a soft interest bias.

Given these factors, the cut-off yields at the auction to be held on July 15 is likely to set the trading range for the coming week. The RBI has scheduled twin auctions for the 2020 and 2032 bonds for a total notified amount of Rs 9,000 crore. In all, bonds are likely to trade in a tight range, unless the RBI drains liquidity from the system.

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