NEW DELHI – Yields on government bonds rose on Monday ahead of the Monetary Policy Committee’s statement on Wednesday as most traders were of the view that the rate-setting committee would raise interest rates by 40 to 50 basis points.
Market sentiment worsened further because of a sharp rise in global crude oil prices, which add to upside inflation risks, strengthening the case for aggressive rate hikes by the Reserve Bank of India’s MPC.
Bond yields and prices move inversely. A rise in yields, therefore, brings with it the risk of marked-to-market losses on bond portfolios and eats into banks’ profitability.
Given that sovereign bond yields are the pricing benchmarks for a vast variety of credit products, a rise in gilt yields drives up borrowing costs across the economy while threatening to erode equity valuations.
When the RBI’s Monetary Policy Committee hikes interest rates, the cost of borrowing rises and bond yields follow suit.
The yield on the 10-year benchmark 6.54 per cent 2032 paper broke past the psychologically significant 7.50 per cent level, rising to a high of 7.51 per cent in early trade.
That level was last seen in February 2019. The 2032 paper had settled at 93.78 rupees or 7.46 per cent yield on Friday.
Meanwhile, Brent crude futures were up $1.80, or 1.5 per cent, at $121.52 a barrel at 2319 GMT. US West Texas Intermediate (WTI) crude futures were up $1.63, or 1.4 per cent, at $120.50 a barrel.
HOW MUCH OF A HIKE?
The RBI’s MPC, which will detail its statement on Wednesday, hiked the repo rate by 40 basis points on May 4 following an unscheduled meeting.
With India’s inflation currently at an eight-year high of 7.79 per cent, it is taken as a given that the MPC will follow up May’s surprise move with more rate hikes. The question is, by how much?
A poll by the Economic Times comprising 23 respondents estimates a rate hike of 25-50 basis points.
Half the market players polled were in favour of a 50-basis-point hike. Most bond traders belong to that camp.
“I am expecting a 50 bps rate hike; if the RBI wishes to manage sentiment, they could perhaps do a 40 bps hike,” a senior treasury official at a large foreign bank said on condition of anonymity.
“There will be more steps to reduce the liquidity surplus too, the RBI has said that they would prefer it within 1-1.5 per cent of NDTL (net demand and time liabilities) so that means that anything beyond 2-2.5 lakh crore would be considered inflationary,” he said.
The liquidity surplus in the banking system is currently estimated at around Rs 4-4.5 lakh crore, market players said.
In May, the RBI also announced a 50-basis-point hike in the Cash Reserve Ratio that banks have to maintain; a move aimed at reducing the massive liquidity surplus that was built up in the banking system during the pandemic.
Dealers said, however, that if the RBI was perceived as being less hawkish in its statement on Wednesday, bond prices could shoot up.
“We could comfortably see a 7-8 basis point rally (fall in yields) if RBI under-delivers,” the dealer with the foreign bank said.
“We have seen a straight rise in yields of 15-25 basis points since the last rate hike and whenever that has happened, there are always those who feel that the market is oversold, especially considering that the yield curve is already very steep. So, if they choose to sound more growth-supportive we could see a rally,” he said.
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