Context: Lower shorter-tenor borrowing by the Government, impending rate cuts, and higher FPI positioning in the sub-7-year tenor could reinstate the bull-steepening bias of the Government Securities yield curve in the near term. Bull steepening refers to a phenomenon where short-term interest rates fall faster than long-term rates, resulting in a higher spread between the two rates and a steepening of the yield curve.
What are Government Securities?
Government securities (G-Sec) are debt instruments (bonds) that governments issue to raise capital. The value at which the G-Sec is issued is regarded as its face value, and the value at which the G-Sec is traded in the secondary market is referred to as its market value.
What is a Bond Yield?
It is the return received by the investor on the capital invested in a particular bond. The yield of a bond depends on its market value.
- If the market value increases above the face value of the bond (the price at which it was purchased in the primary market when it was issued), then the rate of returns on the bond purchase in the secondary market decreases. This phenomenon is often known as the softening of bond yields.
- On the other hand, if the market value decreases below the face value of the bond, then the rate of returns on purchasing the bond in the secondary market increases. This phenomenon is known as the hardening of bond yields.
What is a Yield Curve?
A yield curve is a graph that depicts yields on bonds ranging from short-term debt such as one month to longer-term debt such as 30 years.
Types of Yield Curve & their interpretation
- The yield on bonds depends upon the risk involved. The higher the risks, the higher the yields.
- Normal Yield Curve: Normally, the yield on short-term maturity bonds is lower than that of long-term maturity bonds. This can be attributed to increased risk in the longer term (say 30 years). A normal yield curve indicates that yields on longer-term bonds may continue to rise, responding to periods of economic expansion.
- Inverted Yield Curve: When there are signs of a slowdown in an economy, it would mean that the economy faces risk in the short term. However, the economy may return to normalcy in the long term. Hence, the yield on short-term bonds becomes higher than the yields of long-term bonds. (Inverted Yield Curve). Hence, an inverted yield curve points towards a probable economic recession.
