Bond yields, which had been range bound, got a boost when the Budget revealed that the fiscal deficit target of 3.9% for FY16 would be met. The finance minister was also confident of meeting the 3.5% target for FY17. On the Budget day itself (29 February), yields moved lower by around 15 basis points (bps). One basis point is one hundredth of a percentage point. Subsequently, anticipation of another rate cut was built in.
As the 10-year government security (g-sec) yield inches closer to 7.5% once again, the question is whether the move is sustainable? Is there merit for investors to time a move to duration for an opportunistic gain or is it already too late?
The last secular shift in long-term 10-year g-sec yield started towards the end of 2013 when it was 8.9-9%, and lasted around a year. By the end of 2014, the yield was lower, at around 7.8%. While 2015 started well with the expectation that yields could decisively move below 7.5% due to rate cuts, it didn’t work out as anticipated. By the end of 2015, the benchmark 10-year g-sec yield remained around 7.7-7.8%, despite interim short moves.
Currently, given that inflation is also within the Reserve Bank of India’s comfort zone, the hope for another rate cut has increased. This has shifted the yield decisively lower. However, for the shift to be sustainable, supply pressure needs to be under control. “Supply of paper needs to come down for spreads (between overnight rates and 10-year g-sec yield) to reduce. With the kind of expenditure we heard of in the Budget, in the next two years, the government will need to raise funds. Moreover, state loan auctions and UDAY (Ujwal Discom Assurance Yojana) bonds will keep issuances in the long maturity side heavy,” said Murthy Nagarajan, head-fixed income, Quantum Asset Management Co. Ltd.
