Economy News

Inverted curve: Yield on 1-year bond rises above 10-year bonds to 7.48%

Short-term rate rise a sign of tightening liquidity, possibility of another hike

Indicating the possibility of another rate hike in the near future, the yield on one-year government bonds on Wednesday rose above the benchmark 10-year bonds in what is called an inverted yield curve in the financial markets.

In the Treasury Bill auctions, the 364 days cut-off yield rose to 7.48 per cent as against 7.39 per cent last week. On the other hand, the yield on 10-year bonds was lower at 7.46 per cent. “We have been witnessing the short-term yields rise fast while the longer-term ones have been sluggish,” said Madan Sabnavis, Chief Economist, Bank of Baroda.

In the case of the 91 days Treasury Bill, the yield was 6.97 per cent (6.93 per cent) and 182 days 7.38 per cent (7.30 per cent). The one-year bond yield last traded above the 10-year bond nearly 8 years ago.

An inverted yield curve is when interest rates on long-term bonds fall lower than those of short-term bonds.

According to Sabnavis, inversion of the yield curve is typical of an economy which is slowing down. “Theoretically such a phenomenon is seen heralding a recession. While that is not the case here, a slowdown is imminent as seen by RBI scaling down growth to 6.4 per cent for next year from 6.8 per cent in FY22,” Sabnavis said. At any rate, this theory may not be relevant in India as the curve here refers to the sovereign yields and not the corporate bond yields though the latter are linked to the former. But the secondary market is relatively thin and may not reflect investment intentions of industry, he said.

The US Federal Reserve has hinted at higher rates in the months to come which has affected the market sentiment immediately. “Market believes now that the RBI will also increase rates now. Data on inflation to be released on Monday will be crucial and markets will remain edgy till then,” Sabnavis said.

The RBI has hiked the Repo rate by 250 basis points (bps) to 6.50 per cent since May 2022 to rein in inflation.  Further, the rise in short-term rates is also a sign of liquidity getting tighter. This can be linked to the expected redemption of LTRO or TLTROs as well as advance tax payments in the coming week.

In the US, the policy-sensitive two-year Treasury yield finished above 5 per cent on Tuesday for the first time since June 2007 after Federal Reserve Chairman Jay Powell left open the possibility that policy makers will reaccelerate the pace of interest-rate hikes.

In testimony before the Senate Banking Committee, Powell said that January’s stronger-than-expected economic data suggests “that the ultimate level of interest rates is likely to be higher than previously anticipated.” He also said that “if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

Meanwhile, the 2-year yield is at its highest level in almost 16 years. Its ascent came after the Fed raised its policy interest rate by 450 basis points since last March to tackle inflation that remains more than three times the central bank’s 2 per cent target.

Markets are now expecting the US Fed to hike the benchmark rate by 50 basis points, to a range of 5 per cent to 5.25 per cent, on March 22.

Meanwhile, the Reserve Bank of India absorbed on an average Rs 38,120 crore of liquidity from the system on a daily basis between February 28 and March 5. The net liquidity absorption by RBI stood at Rs 1.14 lakh crore on March 5 and Rs 1.05 lakh crore on March 4.

After remaining in deficit mode for 17 days, RBI absorbed Rs 18, 256.53 crore of liquidity on February 28 on a net basis. Between February 8 and February 27, the average daily infusion by the RBI into the system was Rs 27,107.82 crore.

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