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Informist, Wednesday, Apr. 9, 2025

 

By Aaryan Khanna

 

MUMBAI – The bond markets tend to run ahead of the monetary policy. But for the first time in years, the Reserve Bank of India is now seen in lockstep with the market's reading of the economy.

 

On Wednesday, the Monetary Policy Committee not only voted to cut the repo rate by 25 basis points to 6.00% but also loosened its policy stance to 'accommodative', suggesting further easing in the coming months and allowing traders who had piled into Indian government debt over the last month to breathe a sigh of relief.

 

Yield on the 10-year benchmark gilt, which fell 15 bps in March, is now down 14 bps so far in April. While the pace of future rate cuts hinges on the evolving global situation, the assurance of easier monetary conditions alone opens the door for a further fall in yields. Already, the base case that is building is one of the repo rate being cut by 50 bps to 5.50% by December or March, dealers said. Some market participants expect a major global growth slowdown to begin showing by the end of this month itself, which could lead to frontloading of the rate bonanza.

 

"Tariff shock equal to rate cut therapy – this seems to be the formula that more central bankers are likely to adopt, including the RBI, which offered the recipe that markets were expecting," said Lakshmi Iyer, chief executive officer-investment and strategy at Kotak Alternate Asset Managers. "The icing on the cake was the stance change to accommodative from neutral."

 

On the inflation front, traders said Governor Sanjay Malhotra was "straightforward" on Wednesday and saw relatively few risks, bringing relief to a market whose mood had been soured by February's non-action on stance due to high food inflation. Despite the uncertainty from an escalating trade war between the US and China, market participants are betting on a growth slowdown rather than an inflation blowout. This would allow the RBI to cut policy rates even lower, if needed.

 

MOUNTAIN BUILDING

 

With two repo rate cuts out of the way, the 50-year gilt yield's spread over the 364-day Treasury bill widened to 86 bps on Wednesday from 37 bps on Dec. 31. The immediate effect of the 'accommodative' stance is that the yield curve is likely to ‘bull-steepen' even further, or, in other words, short-term yields will fall quicker and by a greater margin than those on long-term bonds.

 

Wednesday, traders cut their holdings of bonds maturing in 30 years or more and piled into bonds maturing within 10 years.

 

The 'bull-steepening' has already begun to play out. The yield spread on the 10-year benchmark gilt over the five-year benchmark bond has increased by 2 bps to 18 bps after the MPC's decision, with traders predicting it to rise to around 30 bps if the repo rate is cut by another 50 bps. Meanwhile, the 40-year gilt's yield spread over the 10-year hit a multi-year high of 45 bps at close on Wednesday.

 

Bonds maturing in up to 10 years, particularly the five- and seven-year benchmarks, may outperform provided liquidity conditions persist in surplus, as promised by the RBI governor. However, there is a risk the trade will soon become overcrowded and some investors will seek to exit as yields fall--most benchmark yields are at three-year lows--and look for higher-yielding corporate bonds maturing in three to five years, dealers said.

 

"The lower the rates go, the more investors may seek parking money in shorter-term bonds or spread assets, and demand greater premia for longer-term gilts," Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership, said.

 

WHAT NEXT?

 

With the RBI and markets on the same page, traders are now likely to look beyond rate cuts to decide on their next steps as opportunities become more and more specific.

 

"The rate cuts are not going to be the most important theme for the market going ahead," a trading head at a foreign bank said. "There should be a heightened sensitivity to US rates--the beta (relative movement) that had reduced should now go back up."

 

Over the past year, the yield on the 10-year bond has fallen by nearly 80 bps. Wednesday, it settled at 6.44%--the lowest since December 2021--and is seen bottoming out around 6.20%, with investors seen demanding a cushion from the expected terminal repo rate of 5.50% in the current cycle.

 

"Below 6.50% (on the 10-year gilt yield), you could say that many of the positives have been priced in for a 5.50% repo rate," Upadhyay said. "A step lower in yields is only compelling should interest rates be lower, in which the impact of tariffs on growth will be a more important variable than inflation."

 

Moreover, traders think the RBI's comments suggested its liquidity tap may not be opened as it was in Jan-Mar when the central bank injected around INR 5 trillion of durable liquidity. Governor Malhotra put the desired liquidity surplus in the ballpark of 1% of banks' net demand and time liabilities. While this would keep the bucket full, an overflow may not be in the cards, dealers said.

 

While 1% of NDTL translates to over INR 2 trillion, the net durable liquidity surplus stood at INR 1.11 trillion as on Mar. 21, as per RBI data. Since then, the central bank has bought INR 845.41 billion of gilts through its open market operations, with another INR 400 billion still scheduled in April.

 

To be sure, gilts remain a safe investment, with even the most pessimistic trader not expecting the benchmark yield to rise above 6.65%. But things could go awry if Indian bond yields become increasingly driven by the movement of their American counterpart, with inflationary trends in the US likely to push up yields on the safe-haven asset and draw foreign portfolio investors away as gains from rate cuts in India play out.  End

 

Edited by Saji George Titus

 

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