The RBI pulling the bond market strings all the way

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  The RBI pulling the bond market strings all the way

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• The story: The RBI has not had a smooth relation with the bond market players for some months now. It warned the players to "stop demanding high yields" in bond auctions, but the market isn't truly budging. The RBI is upset, and that can be seen in the action unfolding now.
• Cause and effect: The bond market wants bond prices to trade lower across maturities, given the large supply scheduled to flood the market. Note that prices and yields move in opposite directions, so if prices are low, yields would be higher. 

1. The yield on 10-year bonds, which had moved lower to 6.01 per cent after the central bank unveiled the G-SAP 1.0 programme, spiked above 6.12 per cent after the first G-SAP auction on Thursday 15-04-2021. The market was not happy with the quantum of purchase in the 10-year bucket.
2. The bond market was on the edge through 16-04-2021, with 10-year yields trading at around 6.16 per cent, ahead of the weekly auction amounting to ?26,000 crore in which 10-year securities accounted for ?14,000 crore.
3. The auction results reveal that the RBI has not purchased any 10-year paper, though bids worth ?28,000 crore were received for these securities. Ten-year bond yields plunged sharply after 3 pm, when auction results were announced, and later traded at 6.08 per cent again. 
4. The RBI intended to offer bonds worth ?25,000 crore in the first G-SAP auction. The response to the auction was robust, with offers worth Rs. 1,01,671 crore received.
5. The RBI accepted the entire ?25,000 crore that it originally offered to purchase. The problem in the G-SAP auction was that the ?25,000 crore notified by the RBI was spread across maturities. The amount intended for the 10-year bonds was only ?7,500 crore. The bond market wanted higher purchases in this maturity because the government tends to borrow mainly in this bracket. 
6. In the weekly auction scheduled for April 16, 2021, more than 50 per cent was earmarked for 10-year securities. 

• Other reasons: The other reason why 10-year yields moved higher is because the cut-off yield for 6-year bonds bought in the G-SAP auction was 6.13 per cent. While the RBI is trying to cool the yield in the 10-year bonds, the yields on 6, 7, 8 and 9 year bonds are higher than the 10-year, implying that the market does want the bond prices to trade lower across maturities, given the large supply scheduled to flood the market. The WPI inflation number released in April 2021 was yet another dampener for bonds, as WPI rose sharply. 
• Inflation worries: The expected trajectory of the WPI inflation, and its partial transmission into the CPI inflation, going ahead, supports the view that there is negligible space for rate cuts to support growth. That is in spite of the growing uncertainty related to the surge in Covid-19 cases, localised restrictions and emerging concerns regarding migrants returning to the hinterland. This is likely to keep a floor under the G-Sec yields. 
• What market wants: It’s clear that market forces dictate that 10-year yields have to move higher from here. It has to be seen how long the RBI can keep yields in check with these strong arm tactics and threats of ‘tandav’. RBI has openly said its goal is to help government borrow at lower rates, for the massive new borrowing programme in 2021-22.

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