The RBI wants the yield curve to be flatter than it is, with long-term bond yields coming down. For that, it is willing to buy long-term bonds from the market. But bond traders see no reason for a fall in yields, given the expectations on inflation and the government’s medium term fiscal path. Add the fact that the sovereign ends up borrowing the most from the 8-12 year tenure, known as the belly of the curve, and the market wants a fair price for swallowing the supply.
Both sides have not relented. Bond traders have bid at higher yields for every consecutive bond sale auction and even for the open market operations (OMO) auction on Thursday, where the central bank was supposed to buy bonds. The RBI has responded by refusing to accept bids. Bond sale auctions in August saw devolvement, while all the bids at the OMO auction were refused. Meanwhile, the RBI has been conducting operation twists wherein it simultaneously buys and sells government bonds. Behind the twists is the effort to flatten the yield curve. But the RBI has largely failed to do so. In fact, the spread between the 1-year and the 10-year yield has only widened in the last six months.
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