The Hindu Business Line : Bonds likely to trade in tight range

WEEK ending November 8 saw the yield curve become more concave. The benchmark 10-year yield currently stands at 6.83 per cent, after touching an all-time low of 6.81 per cent.

Going forward, bonds are likely to trade in a range. Consider the factors:

First, the long-term spread fell 13 bps week-on-week, and currently stands at 98 bps. This gives little room for bond dealers to bid up prices, convexity advantage notwithstanding. The situation is no different at the short-end; short-term spread fell 2 bps and currently stands at 65 bps. The bout of profit-taking witnessed on Friday suggests that scope for further bid-up in prices appears limited.

Second, most maturity sectors appear rich based on the forward yield curve, especially ones at the long-end. The seven-year and 10-year sectors appear somewhat cheap, but it is a moot point whether bond dealers would sharply bid up prices.

The reason is that the RBI is scheduled to raise Rs 5,000 crore during the week November 18-23, selling 10-15 year bonds in the primary auction. Bidding up prices in the coming week will only tighten the primary yields at the auction, causing more difficulty for primary dealers and banks to engage in carry trade.

These two factors ought to cap any sharp bid up bond prices. This said, the downside from the current levels also appears limited. The reason is that liquidity in the system is comfortable. For instance, the amount outstanding on the one-day repos is Rs 7,885 crore, despite a 25 bps cut in repo rate.

Further, the 25 bps reduction in the CRR will take effect from November 16, thus, increasing system inflows. The flush liquidity will keep yields from rising sharply, while the RBI's OMOs will keep the yields from falling too. In all, bonds are likely to trade in a tight range.

B. Venkatesh

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