Lower coupon on new 10-year bond

The new 10-year bond which came at a coupon rate of 7.72 per cent, much below the existing 10-year benchmark bond, is seen as a signal that interest rates are set to fall further. The coupon on the old 10-year bond, also the benchmark, had come in at 8.40 per cent last year.

The yield on the new 10year bond ended at 7.69 per cent on Friday. This bond will eventually replace the 10-year benchmark bond which ended at 7.86 per cent on Friday, compared with the previous close of 7.88 per cent. Week over week, the yield on the 10-year benchmark bond fell by nine basis points (bps).

“At a broad level, this could be taken as a signal that interest rates could come in lower. We are anticipating another 25-50 bps rate cuts in this financial year. The next rate cut of 25 bps might happen on June 2. But after that, the subsequent 25 bps rate cut would be contingent on the way the actual risks play out,” said Shubhada Rao, senior president and chief economist, YES Bank.

The Reserve Bank of India (RBI) will review the monetary policy on June 2 and the expectation is that the repo rate, at which banks borrow from it, will be cut by 25 bps. The rate is currently 7.5 per cent, after 50 bps of cuts so far in 2015.

“Bond yields should continue to come down. As we near RBI's review, rate cut expectations will mount. Next week, the yields could drop by another four-five bps,” said N S Venkatesh, executive director and head of treasury at IDBI Bank.

The spread or the difference between the yield on the new 10-year bond and the old one is currently 17 bps and Venkatesh believes the spread might get compressed. He also said there is a need for more issuance of the new paper, so that it becomes the benchmark bond.

Last Friday's auction (May 15) worth ~16,000 crore had devolved partially, ~2,708.6 crore, as traders had quoted higher bids while RBI was not comfortable with it. This Friday, the bond auction worth ~16,000 crore sailed smoothly. “The one bond auction that remains prior to the monetary policy (review) might also see stable appetite and if the rate cut indeed happens, the new 10-year bond yield should settle between 7.5 and 7.6 per cent,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund.

Data issued last week showed the Consumer Price Index-based inflation for April had eased to 4.86 per cent, the lowest in four months, after another month of declining food prices. The rise has been undershooting RBI’s latest inflation trajectory, due to which rate cut hopes are being triggered.

The spread between the yield on the new 10-year bond and the old one is currently 17 bps