Alarming uptick in Covid-19 graph stokes traders' fears in bond market

The renewed surge of Covid infections is being seen with some trepidation by the bond market participants, even as further lockdowns could hamper the economy and force the government to borrow more to finance its widening deficit. 
 
The bond market is still not sure if a nationwide lockdown would be feasible, but the alarming rise in Covid cases would crimp economic activity. This, say participants, would be at a time when the country has reopened and the government’s tax collections have gathered pace. 
 
The markets, for now, have taken comfort in the US Federal Reserve (Fed) chairman stating it was in no hurry to withdraw its accommodative stance. The Indian bond market, which has been following the rise in US yields of late, should be able to temper its demand for higher yields. 
 
“Covid seems like a temporary blip (rather than an enduring trend). If the surge ends up impacting the whole country, there could be greater borrowing. But then the central bank would also continue with its accommodative stance for longer. Interest rates wouldn’t be allowed to rise, and the bond market, despite higher supplies, could end up finding itself in a comfortable position once again. The equity markets, on the other hand, could get hit harder,” said Devendra Dash, vice-president-treasury at AU Small Finance Bank. 
 
“While there are fresh pandemic jitters, the immediate concerns are rising oil prices and US yields,” added Dash.

 
On Thursday, a news report stating that the government was likely to cancel the last auction of March owing to better tax collection also helped calm the nerves of bond traders. After witnessing a spike in intraday trade, the 10-year bond yields rose less than 2 basis points from Wednesday to close at 6.2 per cent on Thursday. But the yields are still at an elevated level, considering the Reserve Bank of India (RBI) kept the 10-year yields at around the 6-per cent level for the most part of the fiscal year. 
 
The central bank’s lack of outright open market operations (OMOs), through which it buys bonds from the secondary market, has not helped diminish the sentiment. Rather, the RBI is doing special OMOs, in which it is selling short-term bonds and buying long-term ones to smoothen the yield curve. On Thursday, the RBI announced another special OMO, but the market demand for outright large-sized OMOs has not materialised. 
 
Bond dealers say with the Fed reassuring the markets, the US yields should soften. In such an environment, an OMO announcement by the RBI could bring down yields sharply. 
 
However, all these are contingent upon how the pandemic is contained. Infections in Maharashtra have touched almost 20,000 cases per day — the same as its October 2020 peak. 
 
Like advanced economies, the bond market in India has become reliant on the RBI, in large part because the central bank wanted to control the yields. This may have led to the bond market deciding to ignore the real risks, observed Soumyajit Niyogi, associate director at India Ratings and Research.  
 
“Currently, the rate markets have been on a wait-and-watch mode. The key difference between last year and this one is the clarity on Covid vaccines. However, in case the second wave turns out to be aggressive, market liquidity and credit risk premium will become critical, and the focus will entirely shift to the RBI,” said Niyogi.
 
“The current surge in Covid infections has created palpable fear in the financial markets, with the domestic bond markets in the throes of a jump in yields with a global rally. While the undercurrent of such a fear is well appreciated, it might also impact and rightfully so the RBI’s bias towards an extended liquidity surplus regime,” said Soumyakanti Ghosh, chief economic advisor, State Bank of India Group. 
 
Unlike other central banks, the RBI had started using unconventional tools, even before bringing down the policy rate to a near-zero level. Therefore, the room for a policy rate cut is very much there, noted Niyogi. The rate-cut space can deter a spike in yields, but the “supply overhang will continue to remain a key factor for elevated yields, especially when the room for OMO purchase is limited”, added Niyogi.