IRF slowly gaining in volume as banks start taking position in bond market

Interest rate futures (IRF) are slowly gaining in volume as banks come back to trade in the bond market.
 

Banks were so far keeping away from the spot markets for fear of rising yields. Recently, Finance Minister Piyush Goyal prodded the banks to come back to the bond market. As volume in the spot bond market rises from Rs 150-180 billion in the January-March quarter to more than Rs 350 billion of average volume now, interest in IRF has stated ticking up. 

IRF is used to hedge against yield fluctuations. However, a majority of the volume in IRF, more than 80 per cent by some accounts, are generated by traders. IRF is traded in exchanges. 

The worst that IRF volumes witnessed in recent times was in June. Open interest contracts had fallen to 48,264 on June 29, just before the quarter ended when banks also cut down on their bond market exposures. In a sign that banks have started taking position in IRF, open interest in the IRF segment rose to 110,315 contracts, a three-month high. 

In a rising interest rate scenario, open interest contracts had also thinned in the IRF segment.

  

"Volume in the underlying segment dropped as banks went slow in taking positions in the bond market. IRF volumes, too, fell in sync. Besides, there was a mismatch in liquid instruments in the two markets. The most traded in spot bonds was not necessarily the most traded in the futures segment. This has only recently started correcting" said Hemal Doshi, vice-president, treasury at SBI DFHI.

For example, even as last year's 10-year benchmark had turned illiquid in the spot market, in IRF segment, it was the most traded. And the present 10-year bonds being the most liquid in the spot market, was illiquid in the IRF segment. 

The 10-year bond yield closed at 7.75 per cent, after remaining in the range of 7.8-8.0 per cent for the past few months. Investors say if the yields remain below 7.8 per cent for a few trading sessions, then the yields would fall further, especially as the central bank is injecting direct and durable liquidity through secondary market bond purchases.