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THE yield curve witnessed a non-parallel shift last week. The front-end of the curve flattened further, while the medium and long end shifted upwards, albeit marginally. Going forward, bonds carry downside from the current levels. Consider the reasons.

First, the 10-year yields have found resistance at 7.15 per cent, the cut-off that the RBI fixed at the last auction on 10-year bonds. This gives little room for fall in 10-year yields, unless bond dealers bid up prices based on fresh events.

Besides, yield volatility in the 10-year sector has dropped in comparison with the previous week. This gives less incentive for investors to move to this maturity sector; for lower yield vols reduces convexity gains from duration extension.

Second, the RBI has actively used its OMO window to drain liquidity from the system.

This can be discerned as a signal that the central bank is uncomfortable with tight yields at present. Bond dealers, taking cue from this RBI move, may be wary of bidding up prices.

Third, it was the possibility of a bank rate that kept bonds bid, apart from, of course, the ample liquidity in the system. With the rate cut becoming less likely now, bond dealers may not be compelled to bid up prices.

If anything, yields at the long-end may drop, as these sectors were bid up sharply in anticipation of a rate cut.

Maturity sectors above seven years have witnessed rising yields, and the coming week could see further steepening of the yield curve.

That said, two factors could actually push up bond prices, albeit marginally from the current levels. First, the ample liquidity in the system and, second, a lower cut-off for the 15-year bonds at the auction to be held on April 16 may prompt bond dealers to bid up prices in the secondary market. On the whole, however, the market appears biased on the downside.

B. Venkatesh

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