RBI sends signal to traders that bond yields may head higher

Traders of India’s bonds were unnerved after the central bank cued that rising yields are here to stay by offering surprisingly high borrowing costs at a debt sale.

The Reserve Bank of India sold a 30-year bond on Friday at a cut-off yield of 6.7596 per cent , versus the 6.65 per cent estimated in a Bloomberg survey. The central bank, which acts on behalf of the government for debt sales, also sold another security at a higher yield to raise 20 billion rupees ($267 million) more than planned.

The RBI’s and bond markets perceptions of higher yields may differ, said Arvind Chari, head of fixed income at Quantum Advisors Pvt. If the central bank doesn’t offer support in the form of purchases in the next two to three weeks, it may be guiding yields higher.

The debt sale followed the publication of the latest RBI minutes, which showed that its rate-setting panel has turned less dovish with higher inflation. Traders are now bracing for a further steepening of the yield curve, while holding out hope that the central bank will introduce other measures to ease pressure on the bond market.

Borrowing costs have already been advancing, with the new benchmark 10-year bond yield jumping more than 30 basis points in the past three weeks.

The RBI’s debt purchases in the market has tapered in recent weeks. The central bank may be choosing to stay away to make sovereign debt more attractive to investors amid falling real rates.

The market will hope that Friday’s auction results have finally met the threshold for the RBI to signal something, said Suyash Choudhary, head of fixed income at IDFC Asset Management in Mumbai. What is clear is that the market’s auto mechanism is broken now, and a light touch approach won’t work from here on.