Govt bond yields may rise after higher than expected July inflation print

Experts believe that yield on benchmark 10-year bond might remain at 7.20-7.25%

Yields on government bonds are expected to rise on Thursday due to higher than expected headline inflation print in July, dealers said. However, losses might be limited as core inflation was the lowest in 39 months at 4.9 per cent in July.

Most experts believe that the yield on the benchmark 10-year bond might remain at 7.20-7.25 per cent on Thursday when the market resumes after a holiday, against 7.20 per cent on Monday.

The annual inflation rate, based on the Consumer Price Index (CPI), rose to 7.44 per cent, a 15-month high, against market expectation of 6.5 per cent. It was 4.87 per cent in June.

The rise in July was mainly due to a surge in retail prices of vegetables, particularly tomatoes. The CPI inflation is expected to remain above the Reserve Bank of India’s target of 2-6 per cent in August due to deficient rainfall in parts of the country.

“The headline number is higher than expected, so the yields will rise. But the market is mainly looking at the core (inflation) number which is below 5 per cent. The yield (on the benchmark 10-year bond) should rise to 7.24-7.25 per cent level, it shouldn’t move beyond 7.25 per cent yield level,” said a dealer at a state-owned bank.

“The tomato prices have somewhat eased in the past 10-15 days, and the government is trying to control the cereal prices, so the market will not react that adversely,” he said.

The government has halted the export of non-basmati white rice and has announced its plans to address escalating prices of cereals by offering an additional 50 lakh tonnes of wheat and 25 lakh tonnes of rice from the central pool for sale in the open market.

Tomato inflation in July was at 201.54 per cent, the highest in at least eight years. Experts believe that the surge in consumer inflation is temporary.

“Only solace is the core inflation, which came at 4.90 per cent against 5.10 per cent for the previous month. Bond Markets are likely to react negatively and 10-year government security is likely to test 7.25 per cent,” said Deepak Agrawal, CIO - fixed income and head - product at Kotak Mahindra Mutual Fund.

A segment of the market believes that the yield on the benchmark 10-year bond might move beyond the 7.25 per cent yield mark during the week. Traders are also expected to eye the movement in the US Treasury yields.

“While markets could take some comfort from the softer core inflation print, we think the sheer extent of the spike in headline inflation (which was not priced in) is likely to push up the 10-year bond yield this week. Moreover, the continued firmness in US yields is likely to add to the upward pressure. The 10 year is likely to make its way above 7.25% (last close at 7.20%),” said a report by HDFC Bank.