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Business News/ News / India/  Bond yields signal aggressive RBI rate hikes. What it means for your investment
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Bond yields signal aggressive RBI rate hikes. What it means for your investment

Many banks have already raised their lending rates after RBI's surprise rate hike in May, leading to higher EMIs for borrowers

RBI is widely expected to hike rates by 40-50 bps tomorrow (REUTERS)Premium
RBI is widely expected to hike rates by 40-50 bps tomorrow (REUTERS)

India's benchmark 10-year bond yield today rose to its highest levels in three years, ahead of RBI policy announcement due tomorrow. India's benchmark 10-year bond yield rose to 7.53%, the highest since March 2019, up 4 basis points from its previous close. Bond yields are inversely related to yields. After raising its key lending rate or the repo rate by 40 basis points last month, the RBI is widely expected to sharply hike the rate again tomorrow.

Rising yields indicate that traders expect the RBI to take sharply increase the repo rate going ahead. Economists expect the Reserve Bank of India (RBI) to hike policy rates by 40-50 bps on 8 June.

Many banks have already raised repo-linked and the marginal cost of funds-based lending rates (MCLR) since RBI's surprise rate hike in May, leading to an increase in borrowing costs for retail customers.

Apart from quantum of rate hike, market observers will also be keenly watching RBI's comments on growth and inflation, with oil prices surging above $120 a dollar. 

A fund manger said that the market is expecting rate hike by 40-50 bps tomorrow and any smaller rate hike will be a positive surprise, and short-term bond yields may soften marginally.

“Two crucial numbers coming this week are significant - RBI's rate hike tomorrow and the inflation rate in the US expected on Friday. RBI's rate hike is a foregone conclusion; the only unknown is the quantum of the rate hike," said VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

"A rising rate scenario will improve the margin of the banking sector since deposit rates lag lending rates. The most attractively valued segment in the market now is financials, particularly banking," he added.

Market outlook

“The level of domestic and global inflation will determine the performance of equity markets over the next few months—(1) data showing peaking of inflation could put a cap on bond yields and a floor on equity valuations but (2) data showing further increase in inflation leading to higher-for-longer inflation expectations may result in further increase in bond yields and correction in markets. We expect inflation in India to trend down sharply in 2HFY23 on high base effects but note upside risks to inflation from higher-than-expected domestic food prices and global fuel prices," said Kotak Institutional Equities in a note. 

What should bond market investors do?

“Bond market will experience some volatility as market participants go back to the drawing board and reassess RBI’s potential hikes in next 12 months and their implications of other financial assets," says Edelweiss Mutual Fund.

“Investors with long-term fixed income allocation should probably wait till June MPC policy and allocate a portion of their surplus (25%) after the June MPC outcome and keep allocating 25% each after subsequent MPC policy outcomes in target maturity funds maturing in five to 10-year residual maturities depending on their comfort. This should help them average out their investments and earn attractive tax-adjusted returns if they remain invested till the maturity of these funds."

Target maturity fund are passive debt funds that track an underlying bond index. The portfolio of such funds comprises of bonds that are part of the underlying bond index, and these bonds have maturities hovering around the fund’s stated maturity. The bonds in the portfolio are held to maturity and all interest payments received during the holding period are reinvested in the fund.

Monsoon progress

Rahul Bajoria, MD & Chief India Economist, Barclays, says while this year’s Southwest monsoon made an early landfall on 29 May, the progress of rainfall needs to be tracked closely, as inflation fears continue to escalate.

“The combination of an early onset of the monsoon and healthy progression could help sowing, and reduce inflation pressures in the economy."

 

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Published: 07 Jun 2022, 10:57 AM IST
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