FPI net investment in debt rises to seven-month high on index inclusion hope, but yields soar

Bond yields moved up more than 25 basis points in September due to various domestic and international factors despite the rise in net investment by foreign investors.

Yields on the 10-year benchmark 6.54 percent bond maturing in 2032 has risen more than 80 basis points since it was launched on January 14, whereas the new 10-year benchmark 7.26 percent bond maturing in 2032 rose over 20 basis points, according to Clearing Corporation of India data.

Money market dealers said that the rise in yields can be attributed to higher domestic inflation, an uptick in US Treasury yields, the Reserve Bank of India (RBI) increasing the repo rate, and the rate hike by the US Federal Reserve.

However, it was capped due to inflows by foreign investors in September.

Retail inflation, as measured by the Consumer Price Index (CPI), rose to 7 percent in August, from 6.71 percent in the previous month, due to soaring food prices. It has remained above the central bank’s upper tolerance band for eight months running.

In the September monetary policy, the RBI projected inflation at 6.7 percent in 2022-23, with Q2 at 7.1 percent, Q3 at 6.5 percent and Q4 at 5.8 percent. CPI inflation for Q1 of the next financial year is projected at 5 percent.

“Domestic economic activity is holding up well and is expected to be buoyant in H2 2022-23, supported by festive season demand amidst consumer and business optimism. The MPC (monetary policy committee) is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, restrain the broadening of price pressures and pre-empt second round effects. The MPC feels that this action will support medium-term growth prospects,” the RBI said in its monetary policy statement.

The yield on 10-year US Treasury notes, which was around 3.15 percent at the end of August, hit 4 percent by September-end, the highest levels since 2010. As on September 30, it was at 3.83 percent.

The RBI in the September monetary policy hiked the repo rate by 50 basis points to 5.90 percent to tame inflation. The central bank between May and August in this year raised its policy rate by 140 basis points.

Similarly, in the last month, the US Federal Reserve raised key US interest rates for the third consecutive time by 75 basis points. The increase has taken the policy rate to 3.0-3.25 percent. Federal Reserve chair Jerome Powell made it clear that the US central bank will continue to act aggressively to bring down inflation.

Bond yields have taken cues from the rise in policy rates by the Fed and the RBI.

Initially, government bond yields eased sharply after the expectations of global bond index inclusion, but it went up on dampened sentiments after the inclusion was delayed, among other factors.

“The market is more pessimistic now with domestic inflationary conditions, expected MPC future rate hikes, fear of a global recession, rupee depreciation, among others. While some of these worst situations are easing, the global market still continues to face fresh turmoil. The overall negative sentiments continues to put pressure amongst investors and traders,” said Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincorp, a Mumbai-based debt advisory firm.

Dealers said that with the lower government borrowing target for the second half this fiscal, yields will moderate marginally. Any positive on the inflation front will also help yields to cool off in coming months.