BOND yields retreated last week as risk aversion gripped the market and traders fled

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to safe havens, government securities and public sector bonds.

Risk aversion was triggered by fears of another meltdown in global financial markets, reminiscent of the crisis after Lehman Brothers collapsed in September 2008, and fears of another US recession. That aversion was a global phenomenon, reflected in widening risk spreads. The treasury to eurodollar (TED) yield difference is one key indicator of risk.

A widening spread indicates risk aversion. The six-month TED spread has firmed to 44 basis points, the highest level in 2011.

A one-notch downgrade of US sovereign debt by international rating agency Standard & Poor's had little effect and global investors preferred to stay invested in US treasuries. The widening of spread was triggered by investors moving in large numbers into US treasuries as they preferred to ignore the S&P move, pulling the 10-year US treasury yield to 2.58 per cent, a ten-month low.

Indian sovereign yields also moved down, as traders suddenly turned wary of assuming risk. The 10-year yield dropped sharply to 8.31 per cent, a 15 basis points drop over the previous week. The retreat in yields came despite scarce liquidity. In the interbank collateralised borrowing and lending obligations (CBLO) market, where banks borrow or lend short-term funds against a collateral of government or other eligible securities, rates remained close to RBI's new repurchase (short-term liquidity support to banks against collateral of eligible government securities) rate of eight per cent. The weighted average CBLO rate was 7.9 per cent on Friday. Quantum Mutual Fund fixed income head Arvind Chari said, “Liquidity tightness in short end is largely on account of government borrowings through cash management bills (CMBs). Once the temporary liquidity mismatches are sorted out, yields are bound to correct.“

Increased short-term borrowing and high working capital demand from companies have resulted in an inversion of yields. The scarcity in short-term liquidity showed up in the certificate of deposit (CD) market too. CD rates firmed to 9.63 per cent last weekend. CARE's chief economist Madan Sabnavis said, “Bond yields are not likely to see significant deviation though there are upside risks in the form of inflation and possible RBI interventions.“ Some traders have been accumulating government securities since the beginning of the year, anticipating a further credit slowdown and yield softening.