Bond yields hit 2-week low; curve seen flattening

Bond yields fell to their lowest in two weeks on Thursday and traders said they expect the yield curve to flatten after the government raised the limit on foreign investment in debt. A marginal cut in the October-March borrowing also lifted sentiment.

The 10-year benchmark bond yield ended down 4 basis points at 7.90%, its lowest since September 9 after trading in 7.90-7.96% range intraday. Volumes were heavy at Rs 12,445 crore ($2.7 billion).

The government increased the cap on foreign investment in government and corporate bonds by $5 billion each to $10 billion and $20 billion, respectively.

It also said incremental limit in both corporate and government debt should be invested in securities with residual maturity of over five years. “It’s not that the absolute quantum of the limit that has been changed but also incrementally, one can buy only five years and beyond,” said Manish Wadhawan, director and head of rates at HSBC India in Mumbai. “There was heavy buying in longer tenor bonds. This will cause the yield curve to flatten. It may lead to demand in long-end bonds over a period of time and the 10-year yield can fall to 7.80%,” Wadhawan said.

In the second half of the fiscal year that runs till end-March 2011, the government will borrow Rs 1.63 lakh crore ($35.7 billion), finance secretary Ashok Chawla said on Thursday. “Buying bonds and hedging the portfolio with overnight indexed swaps is a good idea.”

Unlike bonds, the benchmark five-year swaps rate ended up 4 basis points at 7.07%, after touching a high of 7.10% intra-day. The one-year swap rate ended up 7 basis points at 6.43%, after touching 6.46%, highest since August 2. Traders said tight cash conditions are pushing up OIS rates. Banks borrowed Rs 53,690 crore from the central bank’s repo window on Thursday compared with Rs 26,670 crore on Wednesday. Cash conditions had tightened after an outflow from banks of about Rs 60,000 crore as corporates paid advance taxes last week.