Short-term yields fall on surplus liquidity

The steepening of yields at the longer end of the curve has prompted institutions to borrow and lock in long-term funds at current rates, while investors prefer shorter-tenor assets that can be repriced quickly when rates of these assets increase.

Overnight rates have fallen to 5.20% from 5.35%, while the 30-year government bond yield has risen to 7.45% from 7.27%. The benchmark repo rate is currently at 5.25%, following a 125 basis point reduction since February last year.

One basis point is a hundredth of a percentage point.

Agencies

EVEN AS MARKETS RULE OUT MORE RATE CUTS

This divergence in yields across the duration spectrum of bonds has steepened the yield curve in recent days, widening the gap between short- and long-term yields.

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“In a rising rate scenario, one would look to lock in longer tenor borrowings and this is what is happening right now. These funds are then being parked in shorter tenor money market assets with the expectation of deploying them at higher rates a bit later,” said Rajeev Pawar, head of treasury, Ujjivan Small Finance Bank.

Pawar expects the 10-year benchmark yield to test 7% before stabilising in the 6.70%-6.90% range over the next five to six months. Traders say the long end of the curve is adjusting first as markets signal the end of the easing cycle and price in the possibility of higher rates ahead. Short-term yields, however, remain temporarily anchored by surplus liquidity following fund injections into the banking system by the Reserve Bank of India (RBI).

“A steeper yield curve is what one would expect when the rate cut cycle is over. Markets then start to price in the next rate cycle of higher rates, even if the next hike is not immediately visible,” said Abhishek Upadhyay, senior economist, ICICI Securities PD.