Informist, Friday, Apr 5, 2024
By Aaryan Khanna and Nishat Anjum
MUMBAI – Over the last two weeks, government bond yields have been pushed higher by rising crude oil prices and US Treasury yields. Amid all the turmoil from overseas, traders came away from the Monetary Policy Committee's April meeting today with the comfort that India was moving towards rate cuts.
Investors held onto their bond holdings during the seventh straight pause on interest rates by the Reserve Bank of India's rate-setting panel. Even the "withdrawal of accommodation" stance that has signalled tight monetary policy for the last two years was reiterated. But traders had already read the script in February, and were perfectly prepared for it.
The bond market had come into April with no expectation of any change in the monetary policy, and the RBI Governor Shaktikanta Das stuck to the now-familiar refrain. The need for CPI inflation to stay at the 4% target on a durable basis has been one of the stated goals of the MPC since June last, and so the market has been well accustomed to the strident tone on inflation over the last five policy meetings. Today, traders felt a stoic status quo, with no new caveats on the policy aims, were the best approach amid global uncertainty.
"Broadly there are some uncertainties that have come up in the last weeks or months in terms of rising commodity prices and last mile (disinflation) being challenging, as the governor has already stated in the policy," Ashhish Vaidya, managing director & head - treasury & markets, DBS Bank India, said. "This was probably the right thing to do. The policy does not change anything for the...gilts market."
In fact, before starting the post-policy press conference, Das said that the reaction to the policy outcome seemed to show that the central bank and the market's thinking on rates was well-aligned. Gilt traders still expect a rate cut only in October, and the 10-year bond yield to trade in the 7.00-7.20?nd it has occupied since early January. Today, the 10-year benchmark yield ended at 7.12%, the highest in two months.
In his statement, the governor touched upon the key talking point for the market on this front: the rise of Brent crude oil prices above $90 a barrel. "Notwithstanding the cut in petrol and diesel prices in mid-March, the recent uptick in crude oil prices needs to be closely monitored," Das said. "Deflation in fuel is likely to deepen in the near term, following the cut in LPG (liquefied petroleum gas) prices in March." The RBI projects India's crude oil basket to average $85 a barrel, another reason for traders to fret at high crude prices.
With the India Meteorological Department forecasting harsh weather during Apr-Jun, the market was also worried about an upsurge in food prices, already cited by most members of the rate-setting panel as their primary worry on headline inflation. However, the central bank lowered its projection for Apr-Jun inflation to 4.9% from the 5.0% it had projected in the February policy.
Even as both Das and Deputy Governor Michael Patra said that there could be some spillover from food prices and that food inflation continues to show considerable volatility, the RBI held its CPI inflation forecast for 2024-25 at 4.5%. Traders also took heart that it revised the Jan-Mar inflation forecast down by 20 bps to 4.5% as well.
Despite the comfort, money managers are quite shy about trying to get ahead of the RBI on rate cuts after getting bitten by the central bank's past actions. Almost exactly a year ago, overnight indexed swap rate traders had begun betting on rate cuts by December 2023, pulling down yields on rate-sensitive bonds such as those maturing in up to five years.
In June 2023, Das had kicked away rate cut hopes by charting a long path to the 4% CPI inflation target. In August, the RBI introduced an incremental cash reserve ratio that mopped up excess liquidity, pushing up money market rates and short-term bond yields where this cash was invested. Two months later, Das's statement that the central bank could consider open market sales of bonds had spooked traders and spiked bond yields to their highest in 2023-24. When asked about rate cuts in 2024-25, the governor today said he cannot give any forward guidance.
Even in the worst-case scenario, where there are no rate cuts in this financial year, investors have enough confidence that bond yields are not running higher, and will provide a positive rate of return, or carry, over overnight lending rates. The Centre cut its gross borrowing target to 14.13 trln rupees this fiscal from the record 15.43 trln rupees it raised in 2023-24, and foreign portfolio investors are likely to pump in over $30 bln into gilts this financial year. India's gilts are going to be included in bond indices operated by JP Morgan and Bloomberg on Jun 28 and Jan 31, respectively.
"Before the Budget, the yield on the benchmark 10-year government bond was around 7.20%, which is the worst it could get," Laukik Bagwe, vice-president of fixed income at DSP Mutual Fund, said. "India's demand-supply dynamics are very positive and with a new buyer coming into the picture by June and consistently after that, the upside risk to yield from here is just 9-10 bps, even if RBI does not cut rates in 2024-25."
DEMAND, LIQUIDITY FAVOURABLE
The extended status quo should refocus gilt yields on the favourable supply-demand dynamics expected in the near term. Even analysts do not see any rate action or stance change till at least August, two months earlier than the market consensus. In this financial year, the gilt market has unchartered territory, in terms of global bond index inclusion and new investment norms, to navigate, so the focus will shift to how the yield curve plays out in the coming months.
In Apr-Sep, the government will borrow only 53.08% of the 2024-25 gross market borrowing target of 14.13 trln rupees in Apr-Sep, lower than the usual 58% odd that it borrows in the first half. This is set to pull bond yields lower, with short-term bonds likely to outperform longer-dated tenors in the uneven borrowing calendar, steepening the yield curve, dealers said.
"As we turn to the new fiscal, lower-than-expected gross borrowings in Apr-Sep should support bonds across the curve in the near term, followed by lower inflation prints in 1HFY25," Madhavi Arora, lead economist, Emkay Global Financial Services Ltd, said. "Hopes of impending rate cuts, a much lower share in the sub-7 year tenure in Apr-Sep, reversion of system liquidity to be positive in Apr-Sep, and the continued active or passive FPI inflows owing to JP Morgan-index inclusion focused on sub-7 year, amongst others, have augured well for the shorter end of the curve, rather than the longer end – implying bull steepening theme may continue in coming months."
A bull steepening is a change in the yield curve caused by short-term interest rates falling faster than long-term rates. Foreign investors prefer short-term bonds, and only 23.2% of the Apr-Sep borrowing calendar consists of bonds maturing below seven years. Treasury bills of 91-day, 182-day and 364-day maturity have all fallen to multi-month lows this week, as liquidity in the banking system has surged to a surplus of 1.5 trln rupees.
Another factor pulling down the short-term bond yields is the easy overnight rates, which are likely to remain anchored close to the policy rate of 6.50% over the next few months as the RBI allows banking system liquidity to stay near neutral, dealers said. So far in April, the overnight Mumbai Inter-Bank Offered Rate was set at 6.54-6.56%, after being near or above the marginal standing facility rate of 6.75% for most of the last six months.
The only caveat to overnight rates being easy could be the non-regular outflow from the banking system in the form of leakage of currency in circulation. The leakage is substantial at the start of the financial year, and it could be higher this time as the general elections are just around the corner, starting Apr 19. Even with this, liquidity conditions are seen much more favourable than they were in the latter half of 2023-24.
While the macroeconomic factors are not calling for an immediate rate cut, traders have maintained equilibrium for another policy, confident they are nearing the end of a long wait. End
US$1 = 83.30 rupees
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