Bonds Slump to 15-month Low as Auction Cut-offs Disappoint

Mumbai: Bonds slumped to a 15-month low on Friday after the Reserve Bank of India set higher-than-expected cut-off yields at the weekly debt auction, which traders saw as a sign the central bank was getting more comfortable with higher yields.

The 10-year benchmark government bond yield rose to 7.09 percent from the previous session's close at 7.05 percent. It had risen to 7.11 percent, highest since Sept. 2, 2016, earlier in the day.

The spike in yield came after the RBI set a cut-off of 7.41 percent for the 6.57 percent 2033 bond, higher than the 7.32 percent expected in a Reuters poll. Meanwhile, the 7.40 percent 2035 paper's cut-off was set at 7.49 percent compared with an expected 7.42 percent.

A total of 150 billion rupees ($2.33 billion) in bonds were auctioned on Friday by the RBI, which manages debt on behalf of the government.

The central bank's actions on Friday could raise more uncertainty about its intentions regarding bond yields after it last month cancelled an open market sale of debt, a move some traders said was a signal that the RBI felt yields had risen too much.

However, dealers said the RBI needs to tread with caution regarding bond yields.

A senior dealer at a primary dealership said the cut-offs indicated higher yields could be appropriate given "the negatives going ahead such as higher inflation, better growth, potential fiscal slippage."

But the RBI is also not keen to see yields spike too much, considering the government debt held by state-run banks, which would suffer steep mark-to-market losses, making a planned reform plan for the sector much more difficult to implement.

"It (the RBI) doesn't want the public sector banks to be cornered further as the central bank is an equal partner with the government in helping with the bank recapitalisation programme," said the dealer.

The benchmark 10-year bond yield has surged more than 60 basis points since the start of July, with the bond prices heading for their first yearly loss in four.

A likely absence of Life Insurance Corp, India's biggest institutional investor, from the auction on Friday and muted bidding from state-run banks for the long-end papers also contributed to the spike in yields, a few traders said.