Bond investors dumbfounded after RBI's surprising tilt towards rate hike

A surprising hawkish tilt by India’s central bank in its April minutes has left money managers dumbfounded, prompting them to seek a higher risk premium for holding the nation’s bonds.

The benchmark 10-year yield jumped as much as 17 basis points Friday, and ended last week 29 basis points higher, as minutes of the Reserve Bank of India’s April 4-5 meeting boosted speculation policy makers are moving toward raising interest rates. At the gathering, the RBI had maintained a neutral stance and lowered its inflation forecasts.

“The RBI risks losing market credibility,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. in Mumbai. They’ve “managed to sway the bond markets both ways as markets grapple with the assessments of their tone. Investors are building in a risk premium for the uncertainty, not necessarily of macro data points, but on the uncertainty of RBI’s response to it,” he said.

The minutes add to a feeling of whiplash in the bond market that only last month rebounded from its longest rout in two decades amid a slew of supportive measures by policy makers. Investors are selling again as rising oil prices threaten to stoke inflation and worsen government finances. The rupee’s losses have made matters worse, in part because it has driven up the cost of imports.

The yield on benchmark 10-year yield climbed five basis points at 10:30 a.m. Monday to 7.76 per cent. It dropped about 70 basis points from late February to the start of April, before reversing almost all of that decline to climb as high as 7.80 per cent on Friday.

Deputy RBI Governor Viral Acharya said in the minutes he would vote for the start of the “withdrawal of accommodation” at the next meeting in June, according to the document released after the close of markets Thursday. The central bank left its benchmark repurchase rate at 6 per cent at the meeting.

“We are not able to gauge what the RBI’s thinking is,” said Killol Pandya, Mumbai-based head of fixed income at Essel Finance AMC Ltd., which oversees the equivalent of $233 million. “There’s a change in the language of the minutes now, which points toward concerns about inflation. So, market participants are uncertain as to what’s their sense about the economy and the rate cycle. That is translating into volatility.”

Fluctuations in the bond market have been intensifying since October, with a gauge of volatility in 10-year debt climbing to the highest in 13 months last week. Average daily bond trading volume in 2018 is about 20 per cent below that of last year, as state-run banks, the largest holders of Indian sovereign debt, were net sellers on 11 of the first 14 trading days in April.