The yield curve and what to bear in mind
interest rates are, it means different things to different people. Generally, the topic goes to where RBI sets interest rates (“kya lagta hi?”). Inflation and inflationary expectations will be discussed. More involved participants will look at where the 10Y Indian Government Bonds are trading. But as you come closer to the bond desk, the talk will move to the yield curve. So, the focus will be on which tenure security to take – referred to the point in the yield curve. This is because the shape of the yield curve constantly changes and provides opportunities to investors. Various strategies are adopted – barbell, bullet, on-the-run vs off-the run securities to try maximising returns/minimising pain.
Now, the market has been divided into which part of the curve to remain focussed on, as the yield curve has flattened. Whether you take 1y Tbill or 30yGSEC, the rates are around 7%, give or take. The RBI repo rate as everyone knows, is 6.5% — the next move, we and the market believe, will be down, but the timing is not clear basis current inflationary dynamics. Some market participants therefore feel it is better to be in the shorter end (say 5Y) of the curve, as eventual rate cuts will result in curve to become steeper ie. 5Y yields will decline more than say a 15 year, but yet offer protection if the rates were to rise.
Compounding this discussion are developments in the dominant (size and attention seeking!) US markets and the new post-pandemic world that we are in. Historical correlations (India-US interest rate
