All eyes on RBI governor; status quo on rates likely
- The domestic economy is in great shape, and growth requires little immediate policy support
Asset prices moving in a trend will continue to move in the direction of the trend unless acted upon by a disagreeable surprise. Going into the 23 April Monetary Policy Committee (MPC) meeting, the bond market had doubts about whether the trend of policy rate hikes was over just yet. After all, despite six consecutive policy rate hikes—amounting to 250 bps of policy tightening, headline consumer price inflation (CPI) was still hovering above 6%. While consensus was that yields had more or less peaked, markets had pencilled in a final 25 bps rate hike in what was to be the MPC’s final strike. So, when the MPC opted for a status quo policy in the April meeting, it surprised the market, albeit a pleasant one.
When prepared for bad news, ‘no news is good news’. It’s just a ‘pause’ and NOT a ‘pivot’, said the MPC. But tell that to a market that had just dodged a rate hike. Bond prices rallied, and yields fell. This relief rally was further bolstered by a consecutive fall in headline CPI to 5.7% and then to 4.7% in the following months. In addition to statistical effects, the fall in CPI was also aided by continuing moderation in seasonal momentum. A benign inflation trajectory coupled with the narrative of a global slowdown meant that bond markets could play the odds of an earlier policy pivot.
But this narrative explains only a part of the 30 bps fall in the 10-year government bond yield. In fact, the bulk of the move was caused by a one-off spurt in demand for government bonds (G-Sec) from insurance companies and mutual funds amid extraordinary sales in the final quarter of FY2023. The move was further accentuated by less than indicated SDL borrowing (yet again), large G-Sec redemptions in 1QFY24 and higher than budgeted RBI dividend.
We are now at a juncture where bond markets have priced in not only the peak in rates but also an ensuing policy pivot. Interest rate swaps are currently pricing in more than 50 bps of rate cuts by the end of this financial year. With plenty of good news in the price, the bar is very high for yet another surprise MPC on 23 June. Admittedly, the lagged impact of past rate hikes is working through the economy, and inflation is headed lower, at least cyclically. But the MPC may seek a bit more evidence to confirm a durable fall in CPI to ~4% levels. The domestic economy is in great shape, and growth requires little immediate policy support. This gives the MPC the luxury to remain in a ‘wait and watch’ mode.
Since the market isn’t expecting a rate cut immediately, a status quo on rates will be a non-event. The best case for the June policy is a softer ‘stance’ by the MPC. The current policy stance of ‘withdrawal of accommodation’ has already run its course, with pandemic-era policy accommodation behind us. In our view, it’s a matter of time before the MPC moves to a ‘neutral’ stance. If delivered in June, a stance change will likely be accompanied by an unambiguous message suggesting that “a neutral stance favours no policy direction and the policy remains data dependent”. Unless supplemented by a hint of a policy pivot, such a guarded change in stance, too, may fail to provide any lasting impetus.
Sometimes, being predictable is the best that a policy can deliver. This is not to say that the market enthusiasm around a policy pivot will fade. Instead, participants will look at every upcoming economic data for validation of the pivot narrative. Depending on the weight of incremental evidence, it will continuously keep re-pricing the timing and magnitude of the expected policy pivot. The path to lower yields will not be a straight line. In the absence of a major global risk event, we may be in for a prolonged policy pause. While it may test the market’s patience, this by itself may not be enough to derail the narrative. Most likely, the trend of lower bond yields is here to stay. At least, until it isn’t. A wise Investor once said, “When trends change, we change our opinion. And then we wait for the facts, sir!”
The author is the executive vice president and debt fund manager at Kotak Mahindra Life Insurance Co. Ltd. The views and opinions expressed in the column are personal and do not necessarily reflect the opinion of the organization or the Kotak group.
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First Published:6 Jun 2023, 11:12 PM IST
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