Flattening of curve unusual in rate-hike cycle: Yields softening on global index inclusion buzz

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With expectations of India joining the JPMorgan Bond Index running high and the supply of state loans being low, yields have been falling across the curve, flattening it significantly.

The yield on the benchmark bond is down some 24 bps since the end of July following demand from banks, insurers and some foreign investors. The demand for this tenure is expected to be the highest if India does join the index. Experts are penciling in potential flows of $30 billion and expect India’s weight to be 10%, the maximum for a country, in the index.

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The flattening trend is somewhat unusual, say bond market dealers, especially during a rake-hiking cycle, but this time there are many differences. Yields on most bonds with tenures of five years or more have fallen the most – the five-year yield is down some 10-15 bps at a shade under 7%.

The fall in yields has been steeper for bonds with maturities of 10 years or more. For instance, the yield on the 40-year paper has dropped by some 40 bps while it has been about 30 bps for the 30-year paper. The demand is coming from provident funds and insurance companies. “There is a shortage of long-term paper because the quantum of state loans is below the planned levels by about Rs 1.5 trillion,” explained a dealer, adding that insurers and PFs have bought much of the long-term paper.

Radhika Rao, senior economist, DBS Research, wrote on Wednesday that there are expectations that the ongoing review might result in JPMorgan including Indian securities in its GBI-EM fixed income basket. “These hopes have led the rupee and bonds to diverge from global rates since August, barring the hit-to-risk sentiments following a strong US inflation report. Rao pointed out that while bonds initially benefitted from a pullback in commodity prices and a rise in US Treasuries, they strengthened thereafter in the wake of the global selloff.

The exclusion of Russia is one reason experts believe India could find a place in the JPMorgan & Chase Co’s emerging markets bond index as early as mid-September, with the actual entry being in the third quarter next year.