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Informist, Wednesday, Aug. 6, 2025

 

By Aaryan Khanna

 

MUMBAI - The bond market had expected to feel a lesser sting from the Monetary Policy Committee decision Wednesday after a stance change in June had signalled the rate-cutting cycle was at its tail-end. Though comments from the Reserve Bank of India Governor Sanjay Malhotra did not foreclose all hopes of a further cut in rates, bond traders expect yields to drift higher after the jolt Wednesday.

 

The MPC unanimously held the policy repo rate at 5.50% and retained a neutral stance. Traders had expected a rate cut with a signal that further moderation was not coming, or a pause with the RBI acknowledging risks to growth as a precursor to further rate cuts.

 

Instead, the central bank held pat on its GDP growth projection of 6.5% for 2025-26 (Apr-Mar), and forecast June quarter 2026 growth at a robust 6.6%. It brought down its CPI inflation estimate by 60 basis points for FY26 to 3.1%, it forecast Apr-Jun 2026 inflation at 4.9%, the highest expected in six quarters. The combinations of the year-ahead forecasts led the 10-year benchmark yield to jump the most in 14 months on Wednesday, and close at a four-month high of 6.42%.

 

"If the growth-inflation trajectory pans out as forecast, there's no chance that the RBI cuts rates," Rajeev Radhakrishnan, chief investment officer – Fixed Income at SBI Funds Management Ltd., said.

 

Fund managers said their expectations of capital gains from government bonds had virtually faded after the announcements Wednesday. Bankers said they would trim duration risk and try to limit mark-to-market losses, at a time when supply remains tilted to gilts maturing in 10 years or more until September-end. The constant weekly gilt supply pressures will "grind" yields higher, even with some support expected from foreign portfolio investors as US Treasury yields ease on hopes of US policy easing. The Indian 10-year gilt yield is seen in a range of 6.30-6.55% until the October policy statement, dealers said.

 

"Yields on government bonds will be in a range, maybe slightly on the higher side by 10 to 15 basis points," Poonam Tandon, chief investment officer at IndiaFirst Life Insurance, said. "There could be steepness in the yield curve especially after Wednesday's policy and neutral stance." Before Wednesday, the yield on the benchmark 6.33%, 2035 bond has not topped 6.40% since its issuance in early May, and the level was a key technical resistance and the upper end of the trading band over the past few months.

 

Tandon does not expect the spread of the 30-year benchmark gilt over the 10-year yield to widen much further from the current 67 basis points. Long-term bonds are seen out of favour across bank portfolios. Some investors do see both spreads over short-term bonds and absolute yields attractive to pick up the 30-50 year bonds to hold to maturity, as the bonds match their liabilities. Others such as Axis Mutual Fund said the current spreads may be a trap for traders as they cyclically widen at the end of a rate cut cycle.

 

ONE FOR THE GROWTH?

Despite the seeming reticence on further rate cuts, traders held on to the hope the MPC's rate-cutting cycle had not ended yet. The one-year overnight indexed swap rate, the barometer for domestic rate expectations, still showed around a 50% chance of a quarter-percentage-point rate cut by December, dealers said. Economists from ANZ Bank rolled over their rate cut call to October from August, while Goldman Sachs retained its Oct-Dec rate cut call despite risks. MUFG expects a total 50 bps of further rate easing by December.

 

"Forward-looking growth-inflation dynamics set a high bar for any future rate cuts," Vikas Garg, head – fixed income at Invesco Mutual Fund, said. "A small window for a possible final rate cut may open in the October or December policy meetings, but only if economic growth surprises meaningfully on the downside."

 

Growth data will now be even more closely watched by traders as it is seen as making or breaking the MPC's decision on rates. June quarter GDP growth figures will be published before the next policy statement on Oct. 1. However, the data is not expected to show a material crack in economic activity as the US tariffs will kick in only from Aug. 7. Moreover, the headline growth reading in the June quarter will benefit from the statistical effect of a low base and may even exceed the 6.5% growth projection as a low GDP deflator pulls up the real GDP growth, some dealers said.

 

Instead, the MPC may wait for the December policy to cut rates, which is where rate cut bets are coalescing. The central bank will be able to gauge the impact of its cash reserve ratio cuts and the government's tax cuts on demand during the festival season. It will also have the September quarter GDP growth readings. However, even the most optimistic traders, those who see 50 bps of further rate cuts in FY26, do not expect the 10-year gilt yield to fall to 6.00%.

 

"Overall, the possibility remains for a rate cut, but they may wait for the December policy to do it. By then, data should start showing a slowdown in growth," Ritesh Bhusari, deputy head of treasury at South Indian Bank, said.

 

BETTER COMMUNICATION

The RBI's commentary after the rate decision had a low bar to clear, after some in the market termed RBI governor's comments in June a "communication disaster". Bond yields had fallen sharply after the MPC in June cut the policy repo rate by 50 bps, against expectations of a 25-bps cut.

 

The MPC had changed the policy stance to 'neutral' from 'accommodative' and Malhotra had said there was very limited space to support growth further through rate cuts. Several traders had burnt their gilt fingers  after the topsy-turvy sequencing of the announcements in June, including cash reserve ratio cuts. Malhotra had then reiterated that monetary policy had done its bit to support growth.

 

"The market had an unreasonable expectation coming into the policy. The governor said that there was only a little space left, so why would he let go of it so quickly?" Bhusari asked.

 

To be sure, some traders were spooked by the RBI chief's focus on inflation curbing and the guidance of core inflation around 4% in 2025-26 (Apr-Mar). Even at the post-policy press conference, he spent more time on inflation than on exploring the risks to growth.

 

The future trajectory of rates remains uncertain, but traders retained their views after the governor avoided saying the policy easing cycle had ended. Malhotra said the MPC would take rate decisions from policy to policy, basis incoming data.

 

"Overall, the communication was much better and delivered what was needed after the frontloaded rate cuts till June," Radhakrishnan said. "Cycle reversal doesn't seem imminent and at the margin there may emerge space to cut by December."  End

 

Edited by Vandana Hingorani

 

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