Gilt market gets rate hike right, not rest of the policy


Informist, Wednesday, Feb 8, 2023

By Aaryan Khanna

MUMBAI – The government bond market tends to chart a view of the interest rate cycle well in advance of monetary policy decisions, and meetings of the Monetary Policy Committee often serve as a review of the bond market's reading of that rate trajectory.

Before today's monetary policy outcome, the market's view had turned definitely to a final rate hike of 25 basis points, taking the repo rate to 6.50%. The Monetary Policy Committee would then close out its rate hike cycle after nine months, six meetings, and 250 bps of rate increases.

The Market Will Now Look To Read Incoming Data, Along With Commentary From RBI Officials And The Rate-setting Panel

While gilt dealers passed with flying colours on this aspect of the policy--the rate-setting panel did raise rates by only 25 bps, the smallest rate hike in the current cycle--Reserve Bank of India officials gave no indication that they were ready to wind up policy tightening just yet.

Some sections of the market had bet heavily on the RBI hitting the brakes on its rate hike cycle. Chatter before the outcome centred on a less severe monetary policy stance to 'neutral' from 'withdrawal of accommodation'. Gilt traders hoped the RBI would suggest its work on bringing inflation was done, after two headline CPI inflation prints of under 6%. Even a substantial cut in inflation projections would have satisfied the market into a sense that the vigil on price rise was nearing its end.

The RBI refused to throw the market any bones on these hopes. Consequently, the yield on the 10-year benchmark 7.26%, 2032 bond rose 3 bps to 7.34% today, while the five-year benchmark 7.38%, 2027 bond's yield rose 7 bps to 6.24%.

"The market had expected a 25-basis-point rate hike and then guidance for a pause," said Sudarshan Nambiar, head of trading at YES Bank. "They have now left the door open, and you can't rule out another rate hike."

The committee left its stance unchanged, indicating it would not consider further tightening restrictive. The ghost of another rate hike now looms, particularly after RBI Governor Shaktikanta Das stressed on inflation management in no uncertain terms as CPI inflation showed no signs of returning to the central bank's 4% target over the next year.

While the central bank trimmed its inflation projection for 2022-23 by 20 bps to 6.5%, it guided for CPI inflation to average a higher-than-expected 5.3% in the next fiscal year. Moreover, the RBI sees Oct-Dec CPI inflation at 5.0% and Jan-Mar 2024 inflation at 5.6%, dashing the market's hopes of a quick pivot to rate cuts later this year.

"There is a clear upward slope in inflation (projections) starting Oct-Dec this year," said V.R.C. Reddy, head of treasury at Karur Vysya Bank. "The market is drawing the inference that there will not be any rate cuts at least in the calendar year, and perhaps for 2023-24."

The dissonance seems to have been minimal considering the muted rise in gilt yields, but overnight indexed swap rates show a much larger gulf between expectation and reality in the near term. The one-year OIS rate rose 13 bps to 6.81% today.


Despite opening the door to further rate hikes, there is no indication yet that the Monetary Policy Committee will step through it. Market participants highlighted the lack of certainty in today's commentary, but were unsure whether policymakers would be able to justify another increase in rates.

By the RBI's own admission, India had left the worst of inflation behind. The steep rate hikes over the past few months are also likely to kick in and pull down core inflation, which continues to be a pain point for the central bank.

After all, the rate-setting panel did downshift to a token 25-bps rate hike from 35 bps in December, and three successive 50-bps rate increases in Jun-Sep.

"The RBI remained firm on his stance, which might as well lead to another rate hike, so market remains to be uncertain now," said Laukik Bagwe, vice-president at DSP Mutual Fund. "But this sentiment will not last long as market players such as public sector banks and pension funds will always be there to buy and supply will certainly come down after two weeks."

With no fundamental change in the trading view for the benchmark bond until the end of the fiscal year, the 10-year gilt yield may trade between 7.25% and 7.43%, its stomping grounds over the past two months, according to treasury officials.

The market will now look to read incoming data, along with commentary from RBI officials and the rate-setting panel. Upcoming CPI inflation readings remain key to when the central bank will entertain shutting the door on further rate increases.

The US Federal Reserve's commentary and policy actions until the next monetary policy review in India will also be tracked by gilt traders, no matter how much RBI Governor Das insists that rate actions will be driven only by domestic factors.

Overall, the market seems disappointed that it can't say for sure whether this was the last rate hike. In all fairness, perhaps the RBI can't either.  End

Edited by Avishek Dutta

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