T-bill yields continue to surge, at the same level as 10-year bond

Cut-off yields on treasury bills issued by the government continued to rise at primary auctions, with this week’s sale seeing the yield on the 364-day security being set at the same level at which the Centre’s new 10-year bond closed on Wednesday.

At Wednesday’s auction, worth Rs 39,000 crore, the cut-off yields set at the 91-day and 182-day T-bills were each 12 basis points (bps) higher than those set at the previous week’s sale. The cut-off yield for the 364-day T-bill was set 13 bps higher at 7.39 per cent. Bond prices and yields move inversely.

On Wednesday, the government’s recently issued 10-year bond settled with a yield of 7.39 per cent. This essentially implies that investors purchasing one-year securities are receiving the same return as 10-year securities.

Around a year ago, the yield on the 10-year bond was more than 220 bps higher than that on the 364-day T-bill.

Under ordinary circumstances, longer-term bonds fetch higher returns in order to compensate for inflation and growth risks over a longer time frame. Long-term securities pose a greater degree of risk on bond portfolios, with prices of such papers moving sharply in response to a minor movement in yields.

However, these are not usual circumstances for the sovereign bond market. The yield curve has recently undergone a significant flattening as yields on shorter-maturity bonds have climbed at a faster pace than long-term ones. Some analysts believe the yield curve – which could possibly invert over the near term – indicates concerns over slowing economic growth and, consequently, a shift to easier monetary policy later in 2023.

So far in 2023, cut-off yields of 91-day, 182-day and 364-day T-bills at auctions have surged 63 bps, 56 bps, and 50 bps, respectively. Over the same period, yield on the 10-year benchmark bond has risen 11 bps. T-bill yields are included in the external benchmarks that banks use to price loans. Floating rate bonds issued by the Centre also use T-bill yields as their periodic pricing benchmark.

One of the factors behind the quicker rise in short-term bond yields is tighter liquidity conditions in the banking system. With the Reserve Bank of India withdrawing accommodation, surplus liquidity has fallen sharply from close to Rs 8 trillion in April 2022 to around Rs 1.6 trillion in December-January. In February, scheduled tax outflows contributed to episodes of liquidity deficit in the banking system.

However, it is in March and April that the banking system will be tested on liquidity as redemptions of pandemic-era RBI repo operations worth a total of Rs 75,000 crore are lined up. Financial year-end corporate advance tax outflows would exacerbate the strain on liquidity.

The RBI, which recently resumed variable rate repo operations after a long gap, is expected to step up these operations to smoothen out liquidity in the banking system.

“March will be an exceptional month as there will be redemptions, advance tax payments, states hastening their borrowings and also year-end demand from corporates. This will keep rates in the higher range for sure,” Madan Sabnavis, chief economist, Bank of Baroda said.

Another factor that has contributed to the unfavourable view on T-bills is the government’s decision to increase short-term borrowing by Rs 50,000 crore in the current fiscal year. The extra supply, which was announced in the Budget, is in the form of T-bills.

Liquidity and extra supply aside, another key factor that has soured the mood on short-term papers is apprehension of a longer-than-expected monetary tightening cycle by the RBI, given the abrupt surge in inflation in January.

“We expect a couple of rate hikes both from the Fed and the RBI and a pause for the rest of the year. With the yield curve flat at the moment, we are positioning at the short end with an opportunist shift to the long end when it spikes,” said Ashish Ranawade, head of products at Emkay Wealth Management.