What is the bond market reading from the RBI policy?

RBI

Until last week, bond investors were convinced the Reserve Bank of India (RBI) will deliver a modest 35 basis point hike in the repo rate and signal it is done with tightening for now.

While the market got what it wanted on the rate front, the Monetary Policy Committee (MPC) seems in no mood to shed its discomfort with inflation although prices seem to be softening somewhat.

One basis point is one hundredth of a percentage point.

The RBI’s MPC voted for a 35 basis point hike in the repo rate, but kept the stance unchanged, which still remains withdrawal of accommodation.

Further, Governor Shaktikanta Das stressed the point that core inflation, which excludes fuel and food prices, is a cause of worry. Core inflation, or the inflation rate after taking out food and fuel, was around 6 percent in October.

The focus on core inflation in the MPC’s statement has perhaps not been as intense as this time. “On balance, the MPC was of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and contain second-round effects,” the MPC said.

Bond investors view this as a committee high strung by inflation. This is reflected in the seven basis point jump in the benchmark 10-year government bond yield during Das’s address on Wednesday. The 10-year benchmark yield rose to 7.30 percent from 7.23 percent before the release of the MPC statement.

“The overall policy has been more hawkish than expected. There is no concern on growth and so the focus is on inflation. Also the fact that they expect the September quarter of 2023 inflation to be higher than June quarter indicates that they do not expect a disinflation trend,” said R Sivakumar, head of fixed income at Axis Mutual Fund.

The RBI kept its retail inflation projection for FY23 unchanged at 6.7 percent but has projected it to be 5.4 percent in the second quarter of FY24, higher than the 5 percent projected for April-June quarter of that year.

It ain’t over yet

Bond traders believe that more rate hikes cannot be ruled out. “The governor has said that now the RBI wants to bring inflation down to the 4 percent mid-mark once it comes within the 2-6 percent band. Basically, policy tightening will continue is the single biggest message from the policy,” said a bond dealer at a private sector bank.

Economists at HSBC expect the repo rate to reach 6.50 percent, which means that one more rate hike could be expected in February.

Sivakumar pointed out that the RBI’s statement on liquidity indicates that the central bank wants surplus liquidity to perhaps move into deficit territory. “They have said that they want to add liquidity only when they see durable depletion,” he said.

In essence, short-term bond yields could increase in the coming days as the liquidity surplus reduces progressively.

In the policy statement, the RBI has said that it remains ready to inject liquidity even though the banking system is still surplus. Further, the central bank said that it would look for durable signs of a turn in the liquidity cycle through drawdowns in the Standing Liquidity Facility.

Standing Deposit Facility is where banks park their idle funds with the RBI and the average deposits here have been around Rs 1.0-1.5 lakh crore.

Interest rate swaps too may turn higher. The one-year overnight indexed swap, which is the price to hedge interest rate risk on government paper has fallen nearly 30 bps in the past one month on hopes of a softening monetary policy stance.

With the MPC sticking to its stance, expectations of a pause are being pruned.

For the bond market now, the next trigger is the potential supply of bonds from the government borrowing plan. The expectation is that the government will keep FY24 gross borrowing around Rs 15 lakh crore compared with the Rs 14.95 lakh crore for the current year.

“We might see some selling in the bond market in the coming days. However, given the high level of absolute yields on medium- to long-term bonds, we expect the upside to remain capped. We expect the 10-year government bond yield to continue to trade between 7.2 percent and 7.5 percent,” Pankaj Pathak, fund manager at Quantum AMC, wrote in an email.