Illiquid five-year bond distorts yield curve

Lack of five-year bonds in the market has pushed up yields to slightly higher than 10-year G-secs. While this may sound like an inverted yield curve, it can be best described as a ‘hump’ shaped yield curve. An inverted yield curve happens when the short-term bond yields rise above the longer tenure segments. The yield on the five-year bond closed at 7.79 per cent on Friday, while 10 year closed at 7.728 per cent. The one year bond was at 6.797 per cent, two year at 7.376 per cent, while three year was at 7.603 per cent.

While an inverted yield curve is a cause for concern, as it implies a possible recessionary trend, a hump shaped is usually formed when a particular bond is in short-supply. Any illiquid paper, when traded in the market, lacks adequate price discovery and therefore their yield is not a good gauge of interest rate, according to senior bond dealers.

While there are seven papers that mature in 2023, six of them are not traded in the market and are likely in the held to maturity basket of banks. The only representative of the five-year paper is the one issued on April 16.  There is only Rs 60 billion outstanding against this bond, including those held by primary dealers or the underwriters of bond auctions. The outstanding volume is a fraction of what is needed to garner trade volume. On Friday only two trades happened on this paper, RBI data showed.

On the auction on April 26, out of Rs 30 billion on offer against the bond, Rs 29.57 billion remained unsold and the primary dealers had to buy the stock.