Bond Yields Spike As RBI Minutes Show Undivided Focus On Inflation
Bond Yields Snap Two Day Losing Streak
The Reserve Bank of India (RBI) has disappointed markets for a second time. After keeping rates unchanged on December 7, the minutes of the monetary policy committee (MPC) struck a hawkish tone, raising questions about the chances of a rate cut in February.
In response, bonds yields rose 6 basis points on Thursday and closed at the day’s high. The 10 year government bond yield ended at 6.52 percent as compared to 6.46 percent on Wednesday.
What got traders concerned were comments from the RBI governor Urjit Patel which showed that despite the hit to growth from demonetisation, the central bank remains worried about bringing inflation down to the 4 percent mid-point of the flexible inflation target.
The impact of the withdrawal of SBNs (specified bank notes) on growth and inflation, while uncertain, is transitory. Against this backdrop, it is important for monetary policy to stay focused on the medium-term and strive to achieve, on a durable basis, the middle of the notified inflation target range i.e., 4 per cent....Achieving the inflation target of 5 per cent 10 for Q4 of 2016-17 and securing 4 per cent – the central point of the notified target range – remains the primary objective.Urjit Patel, Governor, Reserve Bank of India (Minutes of MPC meet on December 7)
Traders were earlier of the view that Patel may be comfortable with inflation staying in a band of 4 (+/- 2 percent), which would have given the central bank flexibility to cut rates further.
Despite the decision to keep rates steady in December, most were expecting a rate cut in February. Following the release of the minutes, the probability of a rate cut hinges on incoming data on growth and inflation.
The minutes, overall, suggest that RBI’s action will hinge on (1) inflation trajectory moving towards 4 percent on a sustained basis, (2) clarity on quantum and durability of demand slowdown from bank note ban, and (3) duration and depth of financial market volatility.Kotak Institutional Equities Report
Notably, yields have pulled back from the lows hit after demonetisation. The initial surge of liquidity into the banking sector had pushed the benchmark 10-year bond yield down from 6.80 percent to 6.18 percent. Since then, yields are back up at near 6.50 percent levels.
Yields started to move back up after the RBI said that surplus liquidity conditions are temporary and went on to suck out liquidity through the issue of market stabilization scheme (MSS) bonds. The disappointment on interest rates has been the additional factor to push up bond yields.
The 10 year bond yields will remain in the range of 6.25 - 6.50 percent till the next monetary policy meeting in February, where a rate cut still remains as a possibility given the surplus liquidity condition post the demonetisation move and benign inflation situation.Ananth Narayan, Head - Financial Markets, Standard Chartered
Narayan added that he does not expect yields to move up much beyond 6.50 percent and noted that the sharp run up in US Treasury yields would also prevent domestic yields from falling.
On the flip side, the fiscal pressures being faced by the government would prevent yields from falling below 6.25 percent on a sustainable basis, said Narayan.