Floating rate bond yields rise as RBI increases supply

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In addition, over the past few months, the spread between Treasury Bills (T-Bills) available on FRBs has remained compressed, given the rate cycle and the risk associated with it. Spread compression managed smart price appreciation for its holder.

Yields on floating rate bonds (FRBs) have risen over the past few days and are currently trading in a narrow band, investors refrained from buying these bonds after the central bank increased the supply of long FRBs to reduce costs, even though other fixed-maturity papers attract higher yields on a daily basis.

In addition, over the past few months, the spread between Treasury Bills (T-Bills) available on FRBs has remained compressed, given the rate cycle and the risk associated with it. Spread compression managed smart price appreciation for its holder.

On Tuesday, the yield of FRB 2028 closed at 4.4202%, FRB 2034 at 4.7423% and FRB 2033 at 4.7955%. All FRB bond yields were 2-3 basis points higher than the previous close. “The government has increased the supply of FRBs, so the scarcity premium should also go down in the future. From the government’s point of view, it makes sense to issue more long-duration FRBs. This way they can extend maturity with lower interest costs,” said Pankaj Pathak, fund manager, fixed income at Quantum Asset Management.

Market participants said investors are not buying these papers because the yields on fixed-term papers are higher on a daily basis. However, the duration risk on floating bonds is lower than on fixed rate bonds.

“It is possible that even the maximum effective yield of the floating rate note (at least over the foreseeable forecast horizon) will not be much higher than what the fixed rate note of equivalent maturity already offers daily” , said Suyash Choudhary, Head – Fixed Income, IDFC Mutual Fund.

The Reserve Bank of India, as per the indicative borrowing schedule, is expected to sell FRBs worth Rs 32,000 crore till March. Currently, the central bank offers FRBs on weekly bond auctions every fortnight. On October 1, the central bank sold the new FRB 2028 at a threshold yield of 4.0400%, and currently it is trading at 4.4202%, with only five trades outstanding until the market closes.

That was even after Treasury yields hit an 18-month high last week. Usually, in a scenario of rising interest rates, investors buy FRBs to benefit from better yields, because the yields on these papers are linked to Treasury bills. FRB bonds carry a coupon with a base rate equivalent to a weighted average yield of the last three 182-day Treasury bill auctions plus a fixed spread decided by auction.

Public bank dealers expect volumes in the FRB segment to increase after the December policy, where a hike in the reverse repo rate is expected. Most short-term money market rates have already adjusted upwards by 30 to 40 basis points on this expectation.

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