Bonds gain as yields near 15-month high lure investors

India’s 10-year bonds gained the most this week as yields near the highest levels since October 2008 attracted investors.

The yield on the benchmark note climbed on Tuesday on speculation of a pickup in industrial output and China’s decision to rein in bank lending will spur the Reserve Bank of India to raise borrowing costs to curb inflation. The central bank is scheduled to review its monetary policy at a January 29 meeting. The cost of selling 10-year debt climbed by a record 2.3 percentage points in 2009.

“Benchmark bonds have already discounted any monetary tightening that RBI may implement in the near term,” said Anand Bagri, head of fixed-income at Axis Bank in Mumbai. “Yields should remain capped around current levels until the RBI meeting and move lower afterwards. A yield of 7.70% on the 10-year bond looks very good.”

The yield on the 6.35% note due January 2020 dropped one basis point to 7.71% at the close of trading on Wednesday. The price rose 0.07, or 7 paise per Rs 100, to 90.65.

RBI will probably ask banks this month to increase cash reserves by a similar amount, Bagri added. Such a change may push 10-year bond yields to 7.5%, he added. The cash reserve ratio, the percentage of deposits that lenders should keep with the central bank, is now at 5%.

In the derivatives market, 10-year bond futures maturing in March and June were traded at 8.16%. The cost of five-year interest-rate swaps, or derivative contracts used to guard against fluctuations in borrowing costs, increased. The rate, a fixed payment made to receive floating rates, rose to 6.93% from 6.88% on Tuesday.