As RBI and Govt cancel debt auction, bond market lives to die another day

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Over the past two weeks, one Indian bond trader’s stance could be described as the personification of Murphy’s Law – anything that can go wrong will go wrong.

The US Federal Reserve signaled a more aggressive than expected interest rate hike path – putting pressure on India’s central bank to normalize policy and the national government announced its highest ever borrowing program recorded for the upcoming fiscal year.

Against this backdrop, the government’s decision to cancel a planned Rs 24,000 crore bond auction this week, while providing much-needed relief to bond traders, is but a very small mercy when this is the magnitude of the challenge facing the market.

On Monday, the Reserve Bank of India said on its website that based on a review of the government’s cash position, it had decided to cancel the securities sale scheduled for Friday.

Government bond yields fell 9 basis points in response to the development, but compared to the extent of the sell-off the market has witnessed over the past five weeks, the price action Tuesday hardly calls for celebration.

So far in 2022, the yield on the benchmark 10-year government bond has skyrocketed to 46 basis points. Bond prices and yields move in opposite directions and a rise of one basis point on the 10-year benchmark yield is roughly equivalent to a fall in price of around 7 paise.

More importantly, the RBI and government actions do little to improve the overall bond market outlook.

With the government selling bonds worth a whopping Rs 14.95 lakh crore in the next financial year – 43% more than the Rs 10.47 lakh crore budgeted for the current year – adjustments to the This year’s bond offering might be too little too late when it comes to relieving the market.

The vast majority of the current year’s borrowing program has already been completed, with only two additional auctions worth a total of Rs 47,000 crore remaining, excluding the canceled sale on February 11, showed the RBI’s indicative timetable for market borrowing.

Given previous bond sales bond cancellations worth around Rs 30,000 crore, this implies that around Rs 54,000 crore of scheduled gilt supply will not reach the domestic market at course of the current year.

In any case, in the revised estimate for the current financial year, the center has revised down its gross borrowing for the year to Rs 10.47 lakh crore from Rs 12.06 lakh crore pegged earlier, likely due to strong GST inflows, dealers said.

Traders said Tuesday’s price action was mostly driven by traders rushing to cover short positions after the sudden reprieve in central government bond supply for the current week.

“This is an opportunity to short-circuit. The rally is already at a standstill. Once the gap is opened, there is no reason to actually buy,” said PNB Gilts Managing Director and CEO Vikas Goel.

“For the market, it’s neither here nor there; the cat was placed among the pigeons. Next year’s schedule is there so now there can’t be a lasting rally. While they canceled due to cash management; it serves a limited purpose.

While the Center is estimated to have a cash balance of around Rs 3.75 lakh crores, treasury officials doubt that the remaining two auctions scheduled for the current year will also be cancelled.

“A significant portion of the cash balance is made up of state government holdings; we don’t think the government will be able to cancel the other two auctions as well,” said a senior bond broker at a major foreign bank on condition of anonymity.

“If they were in such a comfortable position, they should have announced a deeper cut in borrowing in the budget itself and tried to restore market sentiment. In any case, now with the auction cancellation of this week, they should be able to get a bit better bids in the last two auctions. With the surge in yields, the new 10-year-old would have immediately sold at auction at 7%,” he said.

With banks having already absorbed large government borrowing programs over the past two years and the RBI unlikely to have the ability to extend the same degree of accommodation, dealers see 10-year sovereign bond yields heading towards the 7% mark in early April, sporadically notwithstanding auction cancellations.

The pace of the rise in yields would likely be more gradual than the fierce rise seen so far in the year, as the market will be spared the supply of central government bonds once the borrowing program for this year completed in February, but the direction is nonetheless clear.

What the RBI says in its policy statement on Thursday will now determine how much and how fast the cost of risk-free borrowing in the economy will rise. From this perspective, the market may not draw too much relief as central bank largesse dwindles globally.

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