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Informist, Wednesday, Jan. 29, 2025

 

By Aaryan Khanna

 

NEW DELHI – The Reserve Bank of India's long-awaited announcement to infuse durable liquidity led to an immediate frenzy in the government bond market, with traders seeing the moves as a precursor to a repo rate cut. This led the 10-year gilt yield to slump to a near three-year low of 6.63%. But traders say the yield may have neared its bottom even with a 25-basis-point repo rate cut in sight for next week.

 

The RBI on Monday said it will buy government bonds worth INR 600 billion under open market operation through three rounds of auctions starting Thursday, its first such operation since September 2021. The central bank will also hold a 56-day variable rate repo auction on Feb. 7, the first of this tenure since 2019, and a dollar/rupee buy/sell swap auction on Friday. The measures come soon after data showed the RBI had bought gilts worth over INR 100 billion for the week ended Jan. 17.

 

Many economists and market participants had recently advised the central bank to ease liquidity conditions before it starts lowering rates. The measures announced Monday are therefore, seen as a sign that the RBI is preparing the banking system to smoothly transmit the rate cuts that are expected to follow. Even though the liquidity infusion steps tick off several boxes on the bond market's wishlist, traders are likely to curb their enthusiasm ahead of the Union Budget on Saturday, an event that has a long track record of singeing the bond market.

 

The 10-year benchmark yield is likely to remain near 6.65-6.70% until the first tranche of the announced open market operation, where the RBI has offered to buy the on-the-run 6.79%, 2034 bond. Banks are vying to sell bonds out of their held-to-maturity portfolios at the RBI's OMO auction. Auctions by the central bank are one of the only ways to circumvent tightened rules introduced in 2024-25 (Apr-Mar) on selling out of the held-to-maturity portfolio.

 

Traders may look to prop up prices until the RBI's purchase to secure profitable exits on the bonds, even as the 10-year gilt faces selling pressure in the secondary market ahead of the auction. State-owned banks have already brought a section of their held-to-maturity portfolios out for profitable sale within the 5% limit permissible for shifting bond out of such books, just two months before the current financial year ends in March, dealers said. The 10-year yield closing below the key technical level of 6.68% Tuesday would have put it on a path to 6.50% by March-end, according to technical charts, but that was not to be. The bond shed all gains to end the day at 6.69%, as against 6.68% Monday.

 

"Yesterday's RBI liquidity measures boosted sentiment in the G-sec market, strengthening expectations of a rate cut," V.R.C Reddy, head of treasury at Karur Vysya Bank, said. "However, the positive opening in yields today was partially offset by profit-booking from banks. With yields dropping sharply--almost 22 basis points from last week's peak and now at a three-year low--banks opted to lock in gains ahead of several key rate-sensitive events, including the Budget and the RBI policy decision."

 

After selling bonds to the RBI on Thursday, traders may go slow on re-entering the secondary market ahead of the Budget for FY26 on Saturday, a market holiday. Recency bias aside--gross borrowing numbers in both FY24 and FY25 have been lower than expected--a great deal of positivity is already priced in, making the 10-year gilt yield susceptible to a jolt upward, dealers said. Net market borrowing is seen lower on year in FY26, at INR 11.20 trillion in an Informist poll. Large purchases on the Friday preceding the Budget are unlikely, with the weekly auction for INR 300 billion of gilts also lined up.

 

Provided the Budget does not throw a spanner in the works, gilt yields are primed to retest the lows hit Tuesday heading into the Monetary Policy Committee meeting next week, the first one to be chaired by the current RBI Governor Sanjay Malhotra.

 

Some market participants are even more bullish. "The 10-year gilt should hold at 6.65-6.70% level for the time being, because the liquidity measures, especially the OMO purchases, are quite positive for bonds. Even the Budget should be on expected lines and show fiscal deficit at 4.5% (of GDP) for next year, keeping the demand-supply equation for bonds positive," Prasanna Balachander, head of treasury, ICICI Bank Global Markets Group, said. "...So, going into the MPC we might not see much of a move but post the MPC, if a repo cut is delivered, we should see 10-year yield settling in the 6.50-6.55% range."

 

With the slew of liquidity measures announced after over a month of a deficit, traders view Deputy Governor Rajeshwar Rao – who took over the Monetary Policy Department of the RBI on Jan. 15 – as more proactive in providing adequate liquidity to the banking system. With Rao set to vote at the February MPC meeting as well, some traders are entertaining hopes of even a 50-basis-point repo rate cut from the current 6.50%. A 25-bp rate cut is seen fully priced in around 6.60% yield on the 10-year gilt likely, dealers said. Some caution will also remain due to uncertainties on the global front on both growth and inflation from the election of Donald Trump as US President.

 

Beyond policy, the trajectory of bond yields will depend on whether the RBI actually cuts rates or not – some sections of the market think the central bank may be content to hold rates while normalising liquidity conditions. While a rate cut will prompt the yield curve to reset lower, a pause on rates would result in volatility around current yield levels. Still, the bond market has enough to look forward to even beyond the upcoming policy meeting, which means that the broad direction of yields will remain downward. The RBI is likely to remain a bond buyer as it is likely to continue draining liquidity through its dollar sales, given that the rupee remains under pressure. Even if the RBI does not lower policy rates next week, it's a matter of time before it does. And if a rate cut does arrive next week, it won't be the last one.  End

 

Edited by Vandana Hingorani

 

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