Mumbai: The bond market in India seems to be in a bull grip. The yield on the benchmark 10 year paper, which touched 8.20% last week, has now dipped to 7.88% even as the wholesale price-based inflation crossed market expectation and rose 7.57% in the 12 months to April 19, a fresh three-and-a-half-year high. Bond dealers said the market had expected 7.4% inflation.
The US Federal Reserve cut its policy rate by 25 basis points to 2%: this added to the positive sentiment created after the Reserve Bank of India left rates unchanged this week (1 basis point is one-hundredth of a percentage point).
Bond dealers say yields on the sovereign bonds were high because the market was largely expecting the Reserve Bank to use interest rate as the preferred tool for containing inflation. The bond yield factored in a possible 25-50 basis points hike in the policy rate.
High inflation and the possibility of a rate hike pushed the yield from its January level of 7.40% to 8.20% by April. Dealers say the market was much relieved when RBI did not announce any hike in the interest rate. Instead, RBI governor Y.V. Reddy chose his time-tested method of raising the cash reserve ratio, or the amount banks are required to keep with the central bank, to 8.25% from 8%, to soak up excess liquidity in the system. The bond market was quick to shed the extra yields and government papers rallied. The newly issued 2018 bond yield dipped to 7.94% from its previous close of 8.14% on Tuesday.
“The writing on the wall is very clear that RBI won’t be using interest rate in its fight against inflation,” said J. Moses Harding, executive vice-president and head (wholesale banking group) at IndusInd Bank Ltd.
According to Vijay Anand, associate vice-president, money market and treasury, Development Credit Bank Ltd, the bond market is “slightly bullish” as there is still enough liquidity in the system to support bond trading. Anand expects the yield on the ten-year paper to remain rangebond at 7.80-7.95% in May if the present liquidity situation prevails.
Joydeep Sen, associate vice- president, advisory desk, fixed income, of BNP Paribas, said, “Whenever the inflation number exceeds market expectation, the bond yields go up. This time it didn’t happen, which shows market is showing some level of resilience,” said Sen. He sees the market remaining range-bound with the upper level at around 8% in the next “one or two months”.
Harding of IndusInd hoped the bond yield would retrace its gains in case global commodity prices see a reversal, saying: “Globally the oil prices are coming down, RBI is also optimistic that the inflation would be contained at 5.5%, global cues are also supporting a reversal of commodity prices. If this continues, I guess, the yield would come down to its January level of 7.40%.”
However, not all are so sure.
“The recent pullback in bond yields is a technical retracement, driven primarily by short-covering, after a benign outcome in the annual policy announcement of the RBI,” JPMorgan Chase Bank fixed income analyst Vikas Agarwal said. “Still, headwinds persist for bonds, mainly owing to the outsized proposed issuance, possibility of unanticipated issuance as the fiscal outlook remains highly uncertain and limited possibility of any softening in the RBI’s policy stance.”