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RBI heft, govt excess – the week that took the bond market by storm

Informist, Friday, Feb 12, 2021

By Bhaskar Dutta

NEW DELHI – World over, anyone looking to get a kick out of financial markets would perhaps train their sights on the equity markets that have not only seen valuations soar, but have also recently been the theatre of some hitherto unseen challenges to the established order.

In so far as excitement goes, India's bond market has emerged a worthy challenger.

Over the past four days, the government bond market has seen events unfold that would satisfy the most hardened thrill seekers.

Record-high government borrowing, inexplicable swings in prices, sudden scarcity of the 10-year benchmark bond, and finally, moves by the central bank that would have been unthinkable not too long ago.

The government lined up back-to-back auctions of a record 480 bln rupees this week and the RBI ended up taking select banks in its corner to bid indirectly at the auction to set prices unbelievably higher than what fundamentals warrant.

The coronavirus pandemic has forced the central bank to think out of the box; else, one could have accused the RBI of rigging the market to help the government borrowing.

BONDS THIS WEEK

The government lined up a surprise auction of 220 bln rupees on Thursday, a day ahead of the scheduled auction of 260 bln rupees of bonds today. Thursday's auction was meant to raise the amount pending from the cancelled portion of gilt auctions held on last Friday.

Yields rose in reaction to the announcement of the special auction, and what followed were constant chats by the RBI and the government directly with market participants or indirectly through media, including Informist.

The government kept reminding investors that the RBI would manage the borrowing and that the central bank would not let yields rise despite a massive surge in sovereign bond issuances.

The RBI echoed this sentiment repeatedly, promising bond purchases. But it refused to release a schedule for such bond purchases, which could have better assuaged sentiment.

Sure enough, the central bank unexpectedly announced a 200-bln-rupee open market bond purchase during trading hours on Monday. This had preceded the announcement of a special auction by the government.

Market sentiment see-sawed – comforted by bond purchases by RBI but disappointed by the special bond sale.

The market believed the yield on the benchmark paper should rise past 6.10%, but the government has made it clear it wants the central bank to peg the bond at 6.00% or lower.

Most traders were unsure which way the market was going and were fearful that prices would go against them due to the invisible hand of the RBI.

Apart from an overt purchase of 200 bln rupees of government bonds through a reverse auction, the RBI had started buying bonds in the secondary market. It is just that RBI's hand in the secondary market is not revealed to other traders till the end of the day. 

The RBI's participation is mainly deduced by crunching numbers from inter-participant trade data after the market closes.

THE CRESCENDO

From Wednesday events took a startling turn.

The RBI, at its open market purchases, paid a big premium to the prevailing market price to pick up the 5.77%, 2030 bond, the erstwhile 10-year benchmark.

Traders who had taken short positions, in keeping with the slew of bond sales coming their way, were forced to cover such positions. They usually bet against the benchmark papers while going short.

Though the 5.77%, 2030 bond is the most traded paper, the current benchmark is the 5.85%, 2030 bond. And the short-sellers could not find the current benchmark easily in the interbank repo market as the central bank had been garnering the paper through its secondary market purchases.

The net result was that a segment of traders was left scurrying for the 10-year paper, pushing down its yield. All this was contrary to their intent to push yields higher.

Thursday started with the daily dose of sentiment-boosting comments from government and the RBI, for it was the day of the special auction.

Yields see-sawed in a narrow range and traders were tentative about the outcome of the sale. They felt certain that the auctions would devolve, as the appetite for bonds was weak. But they also knew the RBI would act.

Some expected the RBI to use a special leeway under the Fiscal Responsibility and Budget Management rules to bid directly at the auction. But a government official told Informist there was no such plan.  

That was a dampener for the market briefly.

But a few minutes later, everything changed.

Just as the RBI bought bonds at the open market auction at lower-than-expected yields, it nudged some underwriters to bid for a low fee.  

Given the scale of bond supply lined up and a recent run of poorly-bid auctions, primary dealers were expected to charge high fees to underwrite the debt sale, as evidenced by an Informist poll which predicted the cutoffs for the two bonds up for sale at 25 paise and 30 paise, respectively.

But the cutoff fees came in at nearly 100% lower at 0.25 and 0.35 paisa, respectively.

A case of reading fundamentals incorrectly or just the RBI's hand at work?

Apparently, the RBI informally communicated to certain dealers that the unusually large auctions this week would not disrupt the market and that the central bank was mindful of the huge supply burden staring at the market in the face.

The traders who conversed with the RBI received the impression that demand at the auction would outstrip expectations, perhaps unusually so.

An hour before the closing bell, this confidence was validated. The auction result showed cutoff prices for both bonds were set 30-40 paise above market expectation (5-8 bps lower in terms of yields). This, at a time when there has been no positive shift in the underlying market fundamentals.

Before long, as prices continued to rise in the secondary market, it became apparent that the biggest entity at Thursday's auction may have been none other than the RBI itself.

The RBI is said to have placed indirect bids through primary dealers at the sale. 

Indirect bidders at auctions get stocks transferred to their books from primary dealers. Such transactions, therefore, reflect in secondary market trades of the day.

Clearing Corp of India data on reported deals show nearly 130 bln rupees of the 5.85%, 2030 bond and 90 bln rupees worth of the 5.15%, 2025 bond changed hands after the auction Thursday.

Data released by Clearing Corp after market hours Thursday showed that the 'others' category net purchased nearly 250 bln rupees worth of bonds Thursday, possibly the largest single-day purchase in a few years.

The 'others' category includes insurance companies, provident funds, and, of course, the RBI.

On Thursday, yield on the 10-year benchmark paper closed 5 bps lower at 5.96%, marking an 11-basis-point fall since Feb 5 and the lowest level since the Budget. The 5.85%, 2030 bond was last at 5.97% today. 

There are arguments to be made both for and against such a degree of central bank intervention in the pricing of government bonds in the market.

Reviving the economy during the pandemic does call for low borrowing costs, but transparency in market interventions is equally important.

Pros and cons aside, those wishing for more influence over the central bank may now be echoing US political consultant James Carville, who said he wanted to be reincarnated as the bond market, which can "intimidate everybody".

Today, the government is set to borrow 260 bln rupees at its weekly auction.  The drama is not over yet.  End

Edited by Ranjana Chauhan

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