India's bond investors are sharply paring expectations on how soon the central bank will cut interest rates again, now anticipating a more drawn-out process that could dull the momentum in a market that had surged from last year.
Traders now warn that a sell-off in bonds - under way since prices hit their highs early this year - could accelerate after the Reserve Bank of India held rates on Tuesday and issued a statement that was seen as being cautious on inflation.
Banks, the biggest buyers of bonds, could also trim their existing holdings as the government resumes selling debt and as they start to free up funds to meet an expected rise in demand for loans as lending rates come down.
The bond market has attracted strong foreign inflows, nearly $8 billion so far in 2015 in addition to $26.2 billion in 2014.
But benchmark 10-year bond yields have risen more than 15 basis points to around 7.80% since hitting their lowest in more than 1-1/2 years in early February. They went up 7 bps on Tuesday alone after policy rates were left unchanged.
The five-year overnight indexed swap rate has surged 38 basis points since hitting a 20-month low of 6.72% in late January.
Also Read
"Most market participants' forecasts have got tempered in terms of how much of rate cuts can happen going ahead," said Ashish Parthasarthy, treasurer at HDFC Bank in Mumbai.
"There are no triggers for any rally immediately," he added.
Although expectations remain for up to two more rate cuts of 25 basis points each by the end of 2015, traders say bond prices now reflect bets the RBI's next move won't come until its scheduled policy review in June.
Previously it had been expected to move more quickly, especially given the haste it showed in cutting rates twice this year, by a total of 50 bps, outside of scheduled policy reviews.
Tempering expectations are concern that unseasonable rain could push up winter crop prices, as well as uncertainty about crude oil prices, given problems around the Middle East.
Traders also worry that any paring of bond purchases by banks will come at a time when foreign investors have exhausted their $30 billion quota for government bonds.
Benchmark 10-year bond yields fell nearly 1 percentage point in 2014 on the back of the strong buying by banks and foreign investors.
"With the new fiscal year starting, supply pressure and uncertainty over the timing of the RBI rate cut will keep the bond market cautious," said Kumar Rachapudi, a senior fixed income strategist at ANZ Bank in Singapore.