Bond Markets Jolted As RBI Signals End To Rate Cuts
Yield on government notes due September 2026 surged post RBI’s unexpected policy decision.
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Indian sovereign bonds plummeted after the monetary policy committee (MPC) kept interest rates on hold for a second straight meeting and unexpectedly shifted its stance to neutral from accommodative.
The yield on government notes due September 2026 spiked to close at 6.73 percent, 30 basis points higher than previous close. This is the biggest jump in yields for the benchmark 10-year security since September 2013, data compiled by Bloomberg show.
The rupee rose 0.2 percent to 67.3075 per dollar. Higher domestic yields will make it more attractive for foreign investors to put in money as the yield differential between developed markets and India widens. This can be positive for the Rupee.
End To Rate Cut Cycle
The dramatic reaction in the bond markets was in response to the RBI’s signal that it is done with cutting rates for now. While the decision to hold rates steady on Wednesday was not entirely unanticipated, no one expected the RBI to change its stance to neutral.
In its statement, the monetary policy committee (MPC) said that it remains “committed to bringing headline inflation closer to 4.0 per cent on a durable basis and in a calibrated manner.” Governor Urjit Patel said that the RBI would try to bring inflation down to 4 percent over a “reasonable” time frame. At the same time, the RBI projected that growth will rebound to 7.4 percent in fiscal 2018, suggesting that the central bank does not see any weakness from demonetisation spilling over into next year.
This stance may push yield up to 6.75 percent, said Arvind Narayanan of DBS Bank.
Looks like this might be the end of the rate cut cycle. Unless core inflation eases dramatically or U.S. Fed gives us some dovish signals – both are unlikely – 10-year government securities, currently at 6.65 percent, might go till 6.75 percent. It will move to 7 percent on any hawkish news (on inflation, etc). The rupee will be rangebound for now. Foreign portfolio investors will be happy given that rupee rates are higher and U.S. rates are lower. I think rupee will depreciate gradually towards 67.80 and then 68.50.Arvind Narayanan, ED & Head-Sales Treasury & Markets,DBS Bank
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The shift in RBI’s policy stance has taken the markets by surprise, added Manish Wadhawan, head of interest rates for HSBC India. He also expects the bond yields to settle at close to 6.75 percent after Wednesday’s spike.
The impact on bond markets has been quite severe. We’ve seen the largest sell-off after 2013 when the MSS was hiked by 300 basis points. The bond yields are up 25-30 basis points. The way things are going to pan out, there could be still more pain going forward. The bond markets might stabilise here. The 10-year bond is around 6.75 percent, but that is still 30-35 basis points from the low that we saw.Manish Wadhawan, MD & Head-Interest Rates, HSBC India
Wadhawan doesn’t expect more interest rate cuts from the RBI atleast for the next six months. K Harihar, Treasurer, FirstRand Bank shares the view and also expects no more rate cuts from the RBI in the near term.
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Advantage Short Term Bonds?
The changed view will be negative for long term bonds but short term bonds could see some upside due to easy liquidity in the banking system.
Axis Mutual Fund remains overweight on short-term bonds and sees the 10-year yield between 6.5 and 7.0 percent, if inflation settles between 4.5 and 5.0 percent.
Long bonds is not the place to be. Even if inflation settles between 4.5-5.0 percent, the 10-year should be between 6.5-7.0 percent, which is roughly where it is today. So we are not seeing a great opportunity at the long end but short bonds continue to be at the play. Excess liquidity in the banking system will continue to be the dominant player at the short end of the curve. We continue to be overweight at the short end relative to long bonds.R Sivakumar, Head-Fixed Income, Axis Mutual Fund
All Eyes On Growth Data
Standard Chartered believes the RBI has some flexibility on reducing rates going forward. However, the central bank is unlikely to cut policy rates unless there are “significant shocks either on growth or significant downside surprises on CPI”, said Anubhuti Sahay, head of South Asia Economic Research at Standard Chartered.
The MPC led by RBI Governor Urjit Patel held the benchmark repurchase rate at 6.25 percent, a move that only five out of the thirteen analyst polled by BloombergQuint saw coming.
The committee cited sticky core inflation, which is likely to keep inflation above the 4 percent in fiscal 2018. While the MPC expects growth to decelerate to 6.9 percent in the current year, it forecasts a steep rebound in growth to 7.4 percent next year.
“The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the transitory effects of demonetisation on inflation and the output gap play out,” MPC member told reporters.