Divided MPC gives succour to Bond St, yields seen in a narrow 7.20%-7.60% range

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The yield on the 10-year benchmark bond is likely to trade in the narrow range of 7.20 percent to 7.60 percent in the coming months as dealers discount the possibility of a huge rate hike after MPC members stay divided over rate hikes, dealers said.

"We expect the 10-year G-Sec to continue to trade within the range as the market is optimistic with the news of MPC committee members being divided on further huge rate hikes," said Venkatakrishnan Srinivasan, founder, and managing partner of Rockfort Fincorp, a Mumbai-based debt advisory firm.

The minutes of the recent Monetary Policy Committee (RBI) review meeting show the rate-setting panel will remain more data-dependent for further rate increases even though the members differ in their opinions.

The RBI's internal members in the MPC -- Governor Shaktikanta Das, Deputy Governor Michael Patra, and Executive Director Rajiv Ranjan -- have remained hawkish and expressed the need to continue with aggressive rate actions, citing the need to keep inflation expectations anchored and the comfort provided by resilience in domestic growth. On the other hand, external members -- Ashima Goyal and Jayanth R Varma -- were wary of the lagged impact of monetary tightening.

Varma suggested that a pause is needed after this hike because monetary policy acts with lags, according to the MPC minutes. It may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters.

In the September monetary policy, the central bank raised the repo rate 50 basis points (bps) from 5.40 percent to 5.90 percent, and maintained the policy stance as ‘withdrawal of accommodation’.

Justifying the ‘withdrawal of accommodation’ stance, the RBI Governor mentioned that overall conditions are far more accommodative compared with 2019 when the repo rate was at 5.75 percent and projected inflation was 3.4-3.7 percent. The current repo rate is 5.9 percent and the projected inflation is 6 percent.

"This indicates that the real repo rate (repo rate minus expected inflation) is back on the RBI’s radar and they would hike the repo rate to above-expected inflation levels. The bond market is now pricing for the repo rate to peak at 6.5 percent by end of this year," said Pankaj Pathak, Fund Manager - Fixed Income at Quantum Asset Management Co Pvt Ltd in the Debt Monthly View for September 2022 published on October 7.

The continuous rate hikes by the central bank have narrowed the spread between the repo rate and the 10-year bond, dropping to 160 bps currently.

"The spread between Repo and the 10-year benchmark, which had almost touched 300 bps earlier, has now come down to 155-160 bps. We expect it to fall further to 100-120 bps," said Umesh Kumar Tulsyan, managing director of Sovereign Global Markets, a New Delhi-based fund house.

The yield on the 10-year benchmark bond has risen sharply around 30 bps since the start of September due to rising global yields, higher-than-expected domestic inflation, tighter liquidity conditions and the hawkish monetary policy by the RBI.

The 6.54 percent-2032 bond yield, which was at 7.2146 percent on September 1 jumped to 7.5111 percent on October 14, whereas the new benchmark 7.26 percent-2032 bond yield rose to 7.4696 percent on October 14, from 7.1757 percent on September 1.

"The bond market started on a positive note in September with the 10-year G-Sec yield dipping below 7.10 percent for a brief period on an expectation that Indian government bonds would become part of the global bond index," Pathak added.

"But the momentum couldn’t last long. Rising global yields, higher-than-expected domestic inflation, tighter liquidity conditions and a hawkish monetary policy by the RBI pushed bond yields higher by the month's end," he said.

Earlier this month, the London Stock Exchange Group which manages the FTSE indices said it would continue to keep Indian bonds under watch for inclusion in the FTSE Emerging Markets Government Bond Index.

"The 10-year G-Sec yield was around 7.12 percent mainly due to the expectation of bond index inclusion. However, when it got postponed to next six months, the G-Sec yield went up again during the month," Srinivasan of Rockfort Fincorp said.

About $40 billion was expected to flow into the Indian markets if the inclusion had happened.

Indian bonds give more than 6 percent interest, which is higher than most advanced economies and emerging markets.

Also read: Benchmark bond yields ease as crude oil prices extend losses

Central banks across the advanced economies have kept their fight against inflation on with the US Federal Reserve hiking rates by another 75 basis points in September, the European Central Bank by 75 basis points, and the Bank of England by 50 basis points.

In the same period, the domestic banking system liquidity also declined, pressurising the short-term debt instruments rate. But the RBI seems comfortable with the prevailing liquidity conditions and there was no indication of durable liquidity infusion at this stage. This keeps the OMO purchases of bonds out of the picture, for now, Debt Monthly View for September 2022 report by Pathak said.

The RBI guided to keep the banking system liquidity near neutral through variable rate repo and reverse repo operations.