Bond yields harden as Reserve Bank shows no sign of policy turn

Traders of government bonds were not surprised when the Reserve Bank of India (RBI) announced a sixth consecutive increase in the repo rate on Wednesday. What did dampen the market’s spirits, however, was the lack of a concrete sign from the central bank that it would pause rate hikes going ahead.

The RBI’s Monetary Policy Committee raised the repo rate by 25 basis points to a four-year high of 6.5 per cent on Wednesday. The size of the rate hike was the smallest in the RBI’s current rate-hike cycle, which began in May 2022.

While the slower pace of rate hikes does show the RBI’s acknowledgment of inflation having eased back into its tolerance band of 2-6 per cent, the central bank’s language on Wednesday showed that it was not taking its foot off the pedal as far as inflation was concerned, particularly core inflation.

The market’s hopes of a policy pivot were based on the premise of India’s GDP growth slowing in response to global economic weakness and the sharp rate hikes delivered by the RBI over the last nine months. As traders took stock of the RBI’s renewed concern on inflation, yield on the 10-year benchmark bond rose 3 basis points to close at 7.34 per cent. Bond prices and yields move inversely.

RBI Governor Shaktikanta Das emphasised that the central bank needed to see a decisive moderation in inflation, that core inflation remained sticky and that the economy was showing resilience. The RBI’s forecasts also show that CPI inflation is seen remaining at or above 5 per cent all through the next financial year. The RBI’s inflation target is 4 per cent.

“The policy tone was more hawkish than what most market participants had expected as the RBI recognised that they are still away from achieving their objective of durable disinflation,” HDFC Bank Treasury Research wrote.

“Going forward, the central bank is likely to become more data dependent, and this does not rule out another rate hike in the upcoming policy. We expect the 10-year paper to trade between 7.30 per cent and 7.35 per cent in the near-term,” they wrote.

With the RBI making it clear that its stance of withdrawal of accommodation was linked to the prevailing liquidity surplus in the banking system, traders expect the excess cash with banks to dry up significantly over the next three to four months.

The redemptions of Rs 75,000 crore worth of pandemic-era long-term repo operations in 2023 will significantly reduce the surplus liquidity, with a large portion of the maturities lined up in the next few months, traders said.

From now till the end of the current financial year, the bond market is not expected to witness much volatility as the central government’s borrowing programme is set to end on February 24.

However, going into the next year, the market will need to assess if heavy demand from long-term investors such as insurance companies continues to ensure the smooth passage of the borrowing programme. The government is set to sell a record-high Rs 15.4-trillion bonds on a gross basis in FY24.

“Early days on handling the supply. I feel that in the second half of the next financial year, the RBI will need to come in to help the market with the borrowing programme. They will wait it out in the first half and see how it unfolds,” PNB Gilts MD-CEO Vikas Goel said.

“It’s highly likely that in the third quarter there could be something on the OMO (open market operation) side. US markets also forecast the Fed easing policy around that time,” he said.

Goel sees the 10-year bond in a range of 7.25-7.40 per cent over the next couple of months.