Bond markets have had many negative factors to contend with over the five months. The INR depreciation to record lows against the USD, RBI’s moves to tighten liquidity and worries of a weak economy on government finances have taken yields on the ten year benchmark bond, the 7.16% 2023 bond up by 190bps since the time it was issued in May 2013.
The 7.16% 2023 bond is trading at 9.07% levels, at a price of Rs 88 giving a loss of 12% since issuance. The bond has an outstanding of Rs 77,000 crores since issuance and the market has taken huge losses on the bond. Now at 9.07% levels, the bond is in danger of losing all its volumes leaving holders of the bond high and dry. The reason is that the government has announced the issuance of a new ten year bond in its auction scheduled for the 22nd of November 2013.
The RBI has a limit on the total outstanding bond amount. The limit is at around Rs 90,000 crores at present and this limit is imposed to prevent undue stress on the government when the bond comes up for redemption.
The new ten year bond will have a maturity date of 25th November 2023. The coupon rate on the bond will probably be at 8.75% going by the closing yield on the bond in the when issued market. The spread between the new ten year bond and the old ten year bond is 33bps. There is no reason for two bonds maturing in the same year to trade at spreads of 33bps.
The bond market is facing an uncertain time. RBI repo rate hike is on the cards in December or January given WPI and CPI inflation printing at higher levels for the month of October 2013. The Fed could taper off asset purchases earlier than expected and the INR could face the consequences. Government finances are not doing too well and this is giving rise to worries of higher borrowing.
The market in all this uncertainty does not need to worry about spreads between new and old ten year bonds, especially when the old bond has given huge losses to the market. RBI could well have issued the new ten year bond in 2014, as the market would anyway have expected the issuance of a new benchmark bond for the year.
Bond market will now wonder whether to buy the new ten year at lower yields or hold on to the old ten year at higher yields. Market will also start worrying about what other bonds could go off the run and cause more losses to holders. Too many issues for the market to grapple with in uncertain times.
When Issued Market in the Government Bond Market
There is a market known as the When Issued (WI) market in the government bond market.
The WI market comes into existence when the government auctions bonds as part of its borrowing program.
RBI allows the market to determine the yield/price on the to be auctioned bond even before the auction date.
Buyers and sellers in the WI market will settle the trades in the WI market after the bond auction is through.
Example: The Government of India announced on 18th November 2013 an auction of Rs 7000 crores of a new ten year maturity bond for its auction scheduled on the 22nd of November 2013.
The WI market for the new ten year bond started trading on the 19th of November 2013. The new ten year bond was trading at yields of 8.70% to 8.77% in the WI market.
The WI market for the new ten year bond will close once the bond auction is through on the 22nd of November. If the cut off yield in the auction comes in at 8.75%, the buyers of the bond in the WI market will get deliver of the bonds at the yield at which they bought the bond.