1.Rise in bond yields caused by short selling by traders
As the recent rise in bond yields both in the domestic and the US markets has caused a frenzy in the stocks markets, short selling by market players may be a major reason for the rise in yields.
The strategy of short selling involves the sale of a security which the seller has not yet purchased but borrows from others in the market.
The report noted that the banks and the primary dealers resort to short selling when their view is bearish, that is, the prices of the bond will fall and the yield will rise.
They make money if the bond prices drop and yields rise, and over a point of time, this could become a self-fulfilling prophecy as such short sellers keep on rolling over their borrowed security from the repo market till the time they believe that yields will continue to rise.
According to the SBI report, the only way to break such self-fulfilling expectations is for the Reserve Bank of India (RBI) to conduct large scale open market operations (OMO) to provide necessary steam to the bond market to rally and with an increase in price, many short sold position will trigger stop losses and market players will scramble to cover open positions.
Commodity prices traded higher on Tuesday continuing the buying trend from the previous session. Bullion prices made a strong comeback after the previous week’s decline while base metals prices continued upside with China’s demand. The dollar index ended down by 0.39 percent for the day.
Bullion prices traded higher with spot gold price at COMEX was trading near $1,812 per ounce while spot silver price at COMEX was trading up at $28.12 per ounce in the morning trade. Bullion prices witnessed recovery on weaker dollar and pandemic worries.
Crude oil traded higher with benchmark NYMEX WTI crude oil prices were trading 1.50 per cent up at $62.60 per barrel in the morning trade. Crude oil prices rose to 13 month high on expectations of slower restart of oil output form cold weather impacted Texas area. The resume of refinery operations will bring oil demand back on track.
Base metals complex continued to soar with Copper and Nickel prices traded with more than 1 percent gains. Copper prices traded to the highest levels since 2011 at LME while Nickel prices rallied to the most since 2014 as China resumes trading on Monday. The US stimulus hopes, demand from China, and weaker dollar combined have boosted base metals to trade higher.
MCX Gold April’s future witnessed a good recovery as the price breached the initial resistance of Rs 46,640 (5 Day EMA). Meanwhile, the price is still hovering in the downward sloping channel with immediate resistance near Rs 47,280, followed by Rs 7,560 (21 Day EMA). On the other hand, key support holds around Rs 46,640, followed by Rs 46,200. On the momentum front, RSI has reversed from the oversold zone and now it is moving towards the mid-zone of 50(42) indicating a rebound in the price.
MCX Silver March future has extended its rebound as price breached the initial resistance of Rs 69,680 (5 Day EMA). Meanwhile, the price is trading above the bullish crossover of 5 and 21 days EMA which has strengthened the recovery in Silver prices. On the upside Rs 70,760 holds key resistance, the price needs to sustain above to extend its rally towards the next resistance of Rs 71,800, followed by Rs 72,700.
3.RBI & Bonds
The supply of bonds is huge, and simple economics will tell us that when supply exceeds demand, prices fall. In the case of bonds, yields go up as they move inversely to prices. Simply put, the bigger the bond supply, the higher the yields will climb. The RBI is hoping to bend this logic a bit by participating as a buyer. So far in FY21, the central bank has bought Rs3 trillion worth of bonds, either through auctions or secondary market purchases. Indirectly, it has absorbed a quarter of the government’s borrowing program of Rs 12.8 trillion.
But unlike in the past, the borrowing itself is huge this year and the next year as well. Ergo, it is futile for the RBI to stand in as a big bond buyer for long especially when it has begun normalization of liquidity. Other indirect signals on yields through auction cutoffs and operations twists are effective but only for a short while.
The odds of bond yields rising from here on are piling up. India’s banks are readying to lend more to the private sector and credit growth is expected to pick up. They will have less incentive to keep buying government bonds. The retail inflation outlook looks unfriendly with sticky core inflation and rising fuel prices. Bond traders cannot ignore this. Moreover, globally bond yields are rising and Indian papers cannot be an outlier.
Then there is a supply of bonds from state governments. States have already borrowed close to Rs 6 trillion from the market and may end up borrowing another Rs 1.59 trillion. There are simply not enough willing investors to match the deluge of bonds this year.