From fiscal 2008-09 to 2013-14 RBI had been very aggressive in bond market as Purchasing bond is one of the tools it used to infuse liquidity into the system and hence RBI bought bonds worth more than Rs 5500 Billion is this period (over six years).
However, since last 9 to 12 months Bond yield have been falling due to lower oil prices, falling inflation and improved government finances by easing liquidity conditions. But the main factor would be bond sales conducted by RBI which in turn have implications on market sentiments that actually affects the bond yield to a greater extent.
On Friday 23rd Oct'15, RBI auctioned the first ever 40-year government bond, which witnessed huge interest from long-term investors including insurance companies and pension funds. Infect latest report suggest Bond worth Rs 1000 Cr. scheduled to mature in 2055 (40 years) saw bids participation worth more than Rs 6000 Cr.
RBI plans to sell bonds throughout the remainder of the year and partly sterilize the liquidity released by SLR cut. However the government will not continue to run surplus balance with the RBI (generated through bond sales); infect government will start spending to pull up the economic growth to attain sustainable GDP of 7% and above in long run.
Thus demand for government long term bond would naturally go up along with lower than expected inflation; falling trend in fiscal deficit and effective system liquidity. However this will have a cascading effect on the market sentiments & FII participation; as gradually volatility in bond market will increase generating a paradigm shift from stock market to bond market / Forex for short term purely because of supply & demand rather than a long term view on the bonds.
To add further any immediate (before Dec'15) rate hike from FED's will suck the liquidity out of the stock market even further and Indian markets could witness a correction of up to 4% in short term from current levels of 8350.
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