Sales deluge may mark the end of India’s best bond rally

A rally in India’s sovereign bonds may end soon, as traders shift their focus to upcoming heavy debt issuances from the positive impact of the central bank pausing its rate hikes.

India’s 10-year yield dropped below 7% on Thursday, the first time since April 2022 due to falling crude prices and the prospect of a Federal Reserve rate pause. But now, a potential increase in government debt supply in the coming months and a lack of rate cut expectations in the near term are threatening to stall the advance.

“Markets have moved from 7.45% to 7% and with heavy supply in duration, I would not be very aggressive at this point on the benchmark note from a trading perspective,” said Harsimran Singh Sahni, head of treasury at Anand Rathi Global Finance. “Positioning in 3-5 year would be better.”

The benchmark yield fell 11 basis points in the first week of May, after posting its biggest monthly decline since 2020 last month. The move came as the Reserve Bank of India surprised traders by opting for a pause in its April policy.

The cracks in demand are already starting to show, as the government sold bonds at higher-than-expected cut-off yields at an auction on Thursday. When the benchmark rates are on hold or if the cuts are shallow, shorter-tenor securities offer better returns than longer ones.

India plans to sell about 9 trillion rupees ($110 billion) of bonds in the six months to September, or 58% of the record 15.43 trillion rupees full-year target. The supply deluge may face resistance from buyers especially after the recent rally and with banks holding bonds well above their regulatory limits. 

“I don’t expect much demand coming from the banking sector,” said Deepak Sood, partner and head of fixed income at Alpha Alternatives Fund in Mumbai. Credit demand has been robust and expectations for the RBI to conduct open market operations to support the bond market are low, Sood added.

Inflation Watch

Data on Friday are expected to show consumer price inflation eased sharply to 4.8% last month from 5.66% in March, according to a Bloomberg survey.

“The upcoming inflation numbers are likely to be benign, extending the RBI pause easily to the third quarter, but a rate cut is not the base case here,” said Abhisek Bahinipati, fixed-income trading head at Mirae Asset Capital Markets India. “So with 6.50% as repo rate, government bonds will find it difficult to trade meaningfully below 7%.”

Australia & New Zealand Banking Group is also recommending shorter-maturity bonds in this scenario.

“We have a preference for the front-end of the India government bond curve, having assessed that valuation of short-dated government bonds is not rich versus the policy rate and swaps,” said Jennifer Kusuma, senior Asia rates strategist at ANZ. “We are neutral further out the curve at current levels.”