Bonds see sharp selloff; yields harden as markets expect long pause before further easing
Bonds sold off sharply on Tuesday after the Reserve Bank of India (RBI) governor indicated the 25 basis points rate cut in the repo was “front-loaded”, leading the markets to apprehend a prolonged pause was on the cards. The 7.72% government bond due 2025, rose 8 basis points to close at 7.72% while the 8.40% bond due 2024—the old benchmark—also rose 11 basis points to end at 7.93%. However, yields are expected to trend down again soon.
“Going ahead the yields on the new benchmark could settle down slightly lower in the range of 7.65-7.67% and by June-end, one can expect it to be 7.60%,” said NS Venkatesh, CFO, IDBI Bank.
Ananth Narayan, regional head of financial markets, South Asia, Standard Chartered said although the central bank had trimemd the repo it had also increased the CPI forecast for January 2016 from 5.8% to 6.0%. “This was seen by the market as a little more hawkish than expected. The subsequent cut in the monsoon forecast added to the nervousness in the bond market,” Narayan observed.
Ajay Manglunia, senior VP, fixed income at Edelweiss Securities pointed out that that yields for long term had hardened somewhat because the market sensed a long pause before further easing. “We need to wait and watch the monsoon, stability in oil prices and Fed action for the hike in rates,” Manglunia added.
The RBI raised its projection for the consumer price index (CPI) for January 2016 to 6% while the FY16 GDP growth forecast was lowered to 7.6% from 7.8%. RBI governor Raghuram Rajan observed in the policy statement that with investments weak there was a need to reduce supply constraints over the medium term to ensure inflation eased to 4% in early 2018. The central bank feels it is appropriate to front-load a rate cut and then wait for data that clears uncertainty.
Uncertainty over monsoons and rising crude prices seem to be non-conducive for any further cuts in interest rates at least this calendar year. The possibility of a rate hike in the US has also been an overhang on the bond yields. One more reason which clouds the possibility of inflation getting subdued is the base effect getting faded post August.
Yields on government bond yields have been softening since mid-May on expectations of a rate cut. The 8.40% government bond due 2024 had hit 7.99% in early May due to the global sell-off in bonds but had softened to 7.82 levels in the week before the policy—a fall of 17 basis points. Even the yield on new benchmark had fallen to 7.64% levels.
“With actual overnight rates now coming down by 25 bps to 7.25%, and given slow credit off-take, a yield of 7.95% on the old 10-year bond should be attractive to banks and investors,” Narayan added.
Yields on commercial papers (CP) and certificate of deposits (CD) have trended down by 30-40 basis points since mid-May. Rates were stay flat on Tuesday as the rate cut expectations were already factored into the prices, according to money market experts.