Moneycontrol Pro Panorama | RBI takes away bond market’s liquid courage 

The RBI has been selling government bonds via OMOs in the secondary market.

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As dishes go, the Reserve Bank of India’s (RBI) monetary policy committee served a bland one with absolutely no change in either the policy rates or the stance. Even the words of warning over inflation or those about growth optimism were repetitive. The MPC stuck to its script of a pause, making noises about transitory food inflation and the risks of an unfriendly oil price surge and volatile global financial markets. The RBI didn’t move its forecasts on GDP growth from the previous 6.5 percent and even of retail inflation of 5.4 percent.

The strongest statement from Das, “I would like to emphatically reiterate that our inflation target is 4 percent and not 2 to 6 percent,” was also a repeat of August.

Then what made the bond market furious?

The benchmark 10-year government bond yield surged 10 basis points to 7.31 percent, a reaction that does not befit a status quo monetary policy. It wasn’t because of what is transpiring many miles away in the biggest economy, the US bond market. We will get to that later.

Das announced that the central bank may resort to selling government bonds from its own balance sheet through open market operations (OMO) in order to manage liquidity. First, the RBI has avoided mentioning OMO sales even when asked direct questions by the media in the past. This categoric comment about possible OMO sales shows that the central bank has already planned to do so. To be sure, the RBI has been selling government bonds via OMOs in the secondary market. But the RBI will now have auction-based OMO sales of large quantities. Das said there will be “active liquidity management” from here, in his press meet post policy.

What this also says is the RBI wants liquidity to be neutral or in deficit. That sits perfectly with its policy stance of reining in inflation. Das also pointed out that liquidity is unevenly distributed, something our Chart of the Day on September 27 showed. The upshot is that monetary policy best works against inflation if liquidity is tight.

But tight liquidity also means less funds available to buy government bonds than before. As credit growth picks up, fired further by a festive season frenzy, banks are going to find it even more difficult to spare money for the government. At such a time, if the RBI becomes a seller, who is going to buy this excess dump? Foreign money through the inclusion of bonds in the JPMorgan index is still some time away. Meanwhile, bond vigilantes would want to be compensated for this additional load. Expect more pain in the bond market. That said, our fiscal policy is nowhere as profligate as the American one and our monetary policy is nowhere as tight as that of the US Federal Reserve.

US treasury bond yields have begun to break sentiment in every corner of the global financial market. With benchmark yields having climbed a staggering one percentage point since June in America, the spotlight has unerringly shifted to the cost of capital for everyone, including us. We explain why US bond yields are rocketing now in our Chart of the Day. But why should we bother? After all, the US has been at unprecedented debt levels even before and has come out unscathed. Even the threat of a government shutdown has been more frequent, but the Senate has found a way to extend the lifeline of debt.

The government can perhaps get away with all this, but the bond market has enough vigilantes to shake things up. Yes, bond vigilantes who took the Clinton government of 1990s to the cleaners are back as this FT piece, free to read for Moneycontrol subscribers, pointed out. This explainer from The Financial Times shows who can be at the receiving end of this. The surge in yields would mean mounting losses for investors and that will show up onto balance sheets everywhere, even the RBI.

Bonds are the best thermometer of whether the economy is going great guns or towards the gutter. The US treasury yield is telling everyone that the economy is headed for a hard landing. Mohammed El-Erian lays out the recession narrative in his FT column, free to read for Moneycontrol subscribers. Jay Powell, chair of the Fed, seems unperturbed so far.

Here in India, the situation is rather different. The government’s fiscal position is still reasonably healthy. In fact, tax collections have shown a surge, improving the outlook of the fisc. The transmission of a tight monetary policy onto bond yields has been modest. Ironically, with the OMO sales move, India’s sovereign bond yields may finally be reflecting the country’s monetary policy. All said and done, rising bond yields here or elsewhere should put everyone on guard.

The bond market is where the future is, whether brightening or frightening. Stay tuned.

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(republished from the FT)

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Aparna IyerMoneycontrol Pro