Extreme market volatility originating from the recently announced US job data has prompted India to abandon the trading band for government bonds. This could last for an extended period if markets remain unpredictable.
July 5’s announcement of a better-than-expected US jobs data bolstered the view the Federal Reserve will start reducing its long-running stimulus programme. The United States Dollar Index (DXY), which measures the greenback against a basket of major currencies, rose to 84.588, its highest since July 2010.
While international announcements rarely impact Indian bond market trading, the country’s government opted to relax its trading band for Indian government bonds last minute on July 8, according to the Fixed Income Money Market and Derivatives Association of India, or Fimmda, on its website.
The move is likely in anticipation of a spike in Indian bond yields after strong US jobs data, which pushed up US Treasury yields to multi-year highs. On July 8, 10-year UST stood at 1.75%, according to Bloomberg data.
The benchmark 10-year Indian government bond yield, on the other hand, closed at 7.50% on July 5 from 7.47% on June 28.
“In order to let the market stabilise, as of now, there are no bands that have been published,” said a Mumbai-based head of debt capital market (DCM) at a local bank to Asiamoney PLUS on July 8. “What happens is that there is no constraint on the price discovery mechanism, which means that price can be discovered by the market if there are no specific limits.”
Indian traders note that the removal of the trading bank could persist if market volatility continues to plague the nation in the next few days. As a result, experts are keeping a close eye on several market-driving factors, including fluctuations in the US dollar against the Indian rupee and foreign investment outflows.
“We are just reacting to tapering because there was a lot of foreign institutional investors and that’s gone out on a sustained basis day-in-day-out for the last 30 trading session,” said a Mumbai-based DCM trader at a foreign bank. “For the US dollar versus rupee, if we see a closing that is below the previous day closing for a couple of sessions, that would give some sort of confidence that the volatility has come down.”
Foreign institutional investors have sold about US$6 billion in domestic bonds since the start of June, as part of an exit from emerging markets, sparked by fears of an early end to US stimulus and a slowdown in China’s economy.
The Indian rupee fell, approaching a record low of 60.76 hit the week of July 1.
The trading band is a regulatory precaution that is self-imposed by Fimmda and India’s respective financial institutions, with the aim of preventing bond pricing manipulation. Usually, the prices of government paper is allowed to fluctuate within a narrow trading band of 15 basis points (bp), 10bp and 7.5bp depending on maturity. The midpoint is based on previous closing day prices.
The relaxation of the trading band is a normal occurrence for domestically driven economic events such as the publication of the Indian government budget or a new Reserve Bank of India (RBI) policy, but rarely for external occurrences.
This is why the decision to relax the trading band on July 8 – driven by a combination of financial announcements from the US – came as a surprise to bond traders as it signals that market volatility is much more extreme than anticipated.
“On May 22, when the Bernanke thing happen or the FOMC [Federal Open Market Committee] in June, the market reacted by more than 10bp based on international news, which is extremely rare,” said the DCM trader. “The market had to wait 20 minutes before the trading body can relax the band.”
Financial markets were rattled on May 22 after Federal Reserve chairman Ben Bernanke said tapering could begin “in a few meetings”. He reinforced that at the FOMC meeting in June.
Despite the July 8’s relaxation, traders note that pricing did not surpass the usual 10bp trading band levels.