Mumbai: It seems it is oil price and not the central bank’s monetary policies that is driving the nation’s bond market. And, with oil prices coming down to below $120 (Rs5,028) a barrel, several bond market players say inflation could peak soon, easing the pressure on the Reserve Bank of India, or RBI, to raise interest rates further. The bond yield, too, is indicating a similar trend.
The yield on the 10-year benchmark bond, which rose to about 9.5% on 29 July after RBI’s policy review, has dropped below 9%, RBI’s current policy rate, this week.
RBI had raised the rate at which it lends to banks by half a percentage point and the portion of cash reserves commercial banks need to keep with the central bank by a quarter of a percentage point at its quarterly review.
Bond prices and yields move in opposite directions. Typically, when interest rates are raised, bond prices fall so that yields adjust to the rate change.
On Thursday, the yield rose marginally to 9.10% even as the inflation rate, another trigger for yields, crossed 12%.
“With crude prices coming off the peaks and stabilizing at lower levels, the market is taking comfort and expecting inflation to peak out soon,” said Agam Gupta, head of trading at Standard Chartered Bank.
Crude prices, which had risen above $147 a barrel in July, were at $118.65 on Thursday .
“Markets look at a longer time horizon and this is why the 10-year yield has come down to around 9%. Whether RBI will hike the interest rates further depends on three factors—inflation, money supply growth rate and crude prices,” said Joydeep Sen, vice-president, advisory desk, BNP Paribas. “If these factors remain under control, we can say interest rates are peaking for now and probably the market is taking a longer-term view of falling or stable interest rates.”
RBI has raised its policy rate by 125 basis points and cash reserve ratio by 150 basis points so far this year to rein in inflation. Both cash reserve ratio as well as the repo rate, or the rate at which RBI lends to banks, now stand at 9%.
Inflation is projected to fall to 8% by the year end, crude prices are falling and the money supply growth rate has come down to 20% from 24% a year ago. Bond dealers say they expect money supply growth could fall to 18-19% by the year-end, but still above RBI’s projection of 17%.
Vijay Anand, associate vice-president, money market, Development Credit Bank, however, feels “it’s premature to say that interest rates have peaked” even though he thinks “we are close to that”.
According to Gupta of Standard Chartered, if inflation stays at 12.0-12.5%, the yields will not move much. However, “any move above 13% in inflation will cause fresh concerns in the market”. He expects bond yields to stabilize at 8.90-9.25% in the short term.
The dealers are not reading too much into bond yields falling below the policy rate of 9%.
“It is rare, but not unusual,” said Anand. “In a sudden bullish market where the volumes are thin, the volatility increases... But it is not sustainable and the market soon corrects itself.”
The bond market is, however, worried about the government’s fiscal deficit which will worsen when it pays for the Rs71,700 crore farm debt waiver scheme and implements the sixth pay commission recommendations, raising government employees’ salaries. The government may have to borrow more from the market to implement these programmes and the bond yields will face upward pressure as fresh supplies come into the market.
The government’s borrowing programme for the current fiscal year is Rs1.45 trillionand in the first half of the year it plans to borrow Rs96,000 crore. It has so far raised Rs72,000 crore from the market and is slated to auction Rs6,000 crore worth of a 10-year bond and Rs4,000 crore of a bond maturing in 2032 on Friday.