Govt bond trading volumes drop 25% in October as uncertainty builds

Traders step back from bonds post heavy losses in September; activity largely concentrated in the primary market

Transaction volumes in government bonds, which are the pricing benchmarks for a vast variety of credit products, declined sharply in October as traders kept an arm’s length from the secondary market after racking up heavy losses the previous month.

Uncertainty about the degree to which the Reserve Bank of India may tighten monetary policy further also led to the trading community taking a backseat, with the activity in bonds being largely concentrated in the primary market, treasury officials said.

Data released by the Clearing Corporation of India showed that daily average trading volumes in October were at Rs 35,098 crore, 25 per cent lower than Rs 46,652 crore in September.

Yield on the 10-year benchmark bond rose six basis points in October to 7.45 per cent. The yield on the benchmark bond was last at 7.47 per cent. When bond yields rise, prices fall and vice-versa.

While the movement in the 10-year bond in October was not a striking one, the month before saw the benchmark bond yield registering wild swings, leading to large losses on trading portfolios.

In early September, yield on the 10-year bond came close to falling below the 7 per cent mark, settling at 7.08 per cent on September 8. In a matter of just two weeks, the yield on the bond skyrocketed 39 basis points to trade at 7.47 per cent.  

The key reason for the sharp decline and the subsequent surge in yields was expectation of India’s bonds being included in global indices – an event that did not materialise. Another factor that caused volumes to dry up was a sharp tightening in banking system liquidity, which restricted lenders' ability to manoeuvre when it came to their bond books.

“As liquidity starts getting withdrawn, you have less raw material to play around with. In other words, as rates are rising volumes decline. In a bull market when rates are declining, volumes will be higher. This is generally axiomatic,” PNB Gilts MD, CEO Vikas Goel said to Business Standard.

“The uncertainty is very high. The market feels, but is not convinced enough, that maybe the end of the tightening cycle is near. But without forward guidance from the RBI it doesn’t want to take a bet on that. Traders have burnt their fingers on enough occasions – the bond index inclusion did not happen, etc,” he said.

With the volumes drying up in October, bid-ask spreads, which are a crucial market liquidity indicator, have risen by about 0.8 bps for liquid securities, the CCIL data showed. Wider bid-ask spreads imply reduced market participation and a greater perception of risk.

Price discovery in sovereign bonds is a key determinant of borrowing costs for various entities in the economy such as banks and other firms. Economists the world over, including former RBI Governor Raghuram Rajan, have recently flagged increasing risks emanating from global bond market disruptions.

At present, what is also playing out in the domestic bond market, is an expression of two different sets of views, treasury officials said. On the one side, the trading community – comprised of private and foreign banks, primary dealers and foreign portfolio investors prefer to adopt a wait-and-watch approach when it comes to incremental rate hikes by the RBI. Healthy participation from these players is essential for secondary market volumes.

The other side, comprised of longer-term investors, including insurance and pension funds and public sector banks, are of the view that bond yields are unlikely to rise much further from current levels, given the significant amount of tightening already executed by the RBI. So far in 2022, the RBI has hiked the repo rate by 190 basis points.

The longer-term investors, however, have concentrated their activity in primary auctions rather than secondary market trades.

“The action has moved away from secondary to primary because the trader community is sitting on the side lines and they don’t have strong views on going long. A segment of the market is bearish, or rather, not positive, and that is the trading community – PDs, foreign banks, private banks, FPIs for that matter,” Naveen Singh, head of trading at ICICI Securities Primary Dealership said.

“But the long-term investors like EPFO and insurance companies and maybe a section of nationalised banks – those who are buying for HTM (held-to-maturity), they still see some value at the 7.50 per cent level (yield on the 10-year bond) and that’s why they have been buying and since their appetite is getting satiated in the primary market, no one is coming to do further activity on the secondary side,” he said.

Singh sees yield on the 10-year bond around the 7.50 per cent mark at the end of 2022. While the outlook on bonds is rife with uncertainty, most traders do not see the 10-year bond yield revisiting the 3-year high of 7.62 per cent which was touched in June.

“Traders are of the opinion that rates will go up given what’s happening globally and given the inflationary situation. But, investors are expressing a different idea and that is where the disconnect is coming in,” Singh said.

“The market has come to a conclusion that yields are unlikely to go up significantly beyond 7.50 per cent,” he said.