Portfolio

Bond markets to remain range-bound

Radhika Merwin BL Research Bureau | Updated on January 12, 2018 Published on June 08, 2017

Bond yields that have been yo-yoing between 6.6 per cent and 7 per cent since the beginning of this year, are likely to remain range-bound over the coming months, until a clear picture on RBI’s rate actions and inflation expectations emerge.

While the latest April inflation data that touched a low of 3 per cent, has softened RBI’s tone, sustainability of this trend will be key for the Reserve Bank of India to reverse its neutral stance and cut rates. For now, the RBI’s softer guidance on inflation has rubbed off on the bond markets, and the yield on the 10-year G-sec has fallen marginally by 10 basis points to 6.5 per cent levels.

Given the uncertainty around RBI’s rate action however, bond yields are likely to trade within a tight range, with limited downside from hereon.

Roller coaster ride

Bond markets that began the year on a sanguine note post the Budget — when the Finance Minister retained a prudent fiscal policy — were rattled by RBI’s February Policy, when it reversed its stance from accommodative to neutral. The 10-year G-Sec yield had jumped 30 basis points then, as markets started to factor in the near-zero possibility of further rate cuts.

But as a result of the fallout of excess liquidity, that resulted in the call rate falling below the repo rate, yield on G-sec too started to soften in April, falling to 6.6 per cent levels.

The trend reversed once again, after RBI raised the reverse repo rate —- the rate at which banks lend short-term funds to RBI — by 25 basis points to 6 per cent, in the April policy. Yields on 10-year G-Secs trended higher in the month of May, back to 6.9 per cent levels.

But the April CPI inflation kindled hopes of further rate cuts again. The 10-year G-sec yield fell to 6.6 per cent levels over the past month.

What now?

While RBI has lowered its inflation expectation for the current fiscal on the back of benign April inflation numbers, it is still awaiting more clarity. Risk of fiscal slippages, HRA increase under the Seventh Pay Commission, and base effect trickling in, can exert upward pressure on inflation. This could limit RBI’s scope to cut rates further.

RBI not conducting OMOs — buying of government bonds — at the same pace as last year, can also lead to domestic yields moving up.

Selling pressure from banks can also keep government bond prices depressed and yields higher. From the month of March, both PSU and private banks have been net sellers.

In the month of March, for instance, PSU banks were net sellers to the tune of around Rs 18,700 crore and in April about Rs 19,500 crore. In the month of May until June 2, PSU banks turned aggressive, selling (net) around Rs 33,700 crore of G-secs. During this period, private banks were net seller in government securities to the tune of Rs 12,600 crore.

Bond investors should stay clear of duration calls (betting on rate movements) and instead invest a chunk of their debt fund investments in short-term income funds that carry less volatility in returns.

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