Indian government bonds extended their rally on Monday, November 9, as Brent crude slid to around $94.6 a barrel and hopes of a US-Iran peace deal kept risk sentiment calm. But beneath the rally, traders are bracing for a harder question: how much further will the Reserve Bank of India (RBI) raise interest rates?
The benchmark 10-year bond, the 6.94 per cent 2036 paper, ended the day at a yield of 7.1529 per cent, nearly 4 basis points below Friday’s close. It follows a sharp 22-basis-point drop last week, the steepest weekly fall in almost seven years, set off by a Democratic sweep in the US midterm elections, which revived hopes of progress toward ending the Iran conflict.
Crude slide powers the rally
Oil has been the main driver of sentiment. Brent crude, which tumbled more than 16 per cent last week, fell another 3.6 per cent on Monday to around $94.6 a barrel. US President Donald Trump has indicated that fresh attacks on Iran are highly unlikely while talks continue.
Cheaper crude matters a lot for India, the world’s third-largest oil importer. It has eased concerns about the inflation outlook, the rupee and the fiscal deficit, and investors have scaled back bets on aggressive rate hikes by the RBI. Overnight indexed swap rates reflected the shift, with the one-year rate down 5.25 basis points to 6.28 per cent and the five-year down 8.5 basis points to 6.395 per cent.
The rate-hike shadow has not gone away
Even so, the market is far from convinced that the tightening cycle is over. The RBI may raise interest rates by as much as 75 basis points in the coming months, adding to the 25-basis-point hike on October 7, according to IDFC First Bank and Deutsche Bank. That October move took the repo rate to 5.50 per cent, with the standing deposit facility at 5.25 per cent and the marginal standing facility at 5.75 per cent.
Short-term bonds look the most exposed. “Short bonds are more sensitive to immediate interest-rate expectations and liquidity conditions,” said VRC Reddy, head of treasury at Karur Vysya Bank. “I expect such notes to underperform as more rate hikes are still on the cards given how the inflation trajectory is poised.”
The gap between five-year and 10-year yields has narrowed to about 32 basis points from 37 basis points at the end of August, according to data compiled by Bloomberg, and IDFC First Bank and Quantum Asset Management are among those expecting the curve to flatten further.
The government cancelled a sale of 182-day treasury bills last week, and yields on treasury bills are near their highest in over a year.
Liquidity is tightening fast
The cash squeeze is real and measurable. The RBI has been absorbing liquidity from the banking system, and the excess cash surplus has dwindled to Rs 2.3 lakh crore as of November 5, from a record Rs 11 lakh crore in early September. The central bank has drained liquidity through sell-buy currency swaps and Rs 1.25 lakh crore of bond sales via open market operations.
What to watch this week
The focus now turns to the data. India’s consumer price inflation for October is due on Thursday. A Reuters poll expects it to rise to 5.93 per cent from 5.54 per cent in September, close to the upper end of the RBI’s 2 to 6 per cent tolerance band. A Bloomberg survey expects price growth to hit the 6 per cent upper tolerance level for the first time in two years.
In the United States, inflation figures are expected on Tuesday. Stronger-than-expected American jobs data has lifted the probability of a Federal Reserve rate hike in December to about 80 per cent, according to the CME FedWatch Tool. “If the Fed hikes rates in December, the RBI may follow,” said Gopal Tripathi, head of treasury and capital markets at Jana Small Finance Bank.
Indian debt markets will remain shut on Tuesday for a local holiday, so trading resumes midweek, with both the US inflation reading and the domestic print likely to set the direction. Softer oil, a smaller geopolitical risk premium and shifting rate expectations have driven the recent rally. Whether yields can keep falling will depend on the coming numbers.
FAQs
Why did Indian bond yields fall on November 9?
Brent crude fell 3.6 per cent to around $94.6 a barrel and hopes of a US-Iran peace deal grew. The 10-year yield ended at 7.1529 per cent, nearly 4 basis points below Friday’s close.
How much could the RBI raise rates?
IDFC First Bank and Deutsche Bank expect the RBI may raise rates by as much as 75 basis points in the coming months, on top of the October 7 hike that took the repo rate to 5.50 per cent.
Why is banking liquidity tightening?
The RBI has drained cash through sell-buy currency swaps and Rs 1.25 lakh crore of open market bond sales. The surplus has fallen to Rs 2.3 lakh crore from Rs 11 lakh crore in early September.
When is India’s October inflation data due?
On Thursday. A Reuters poll expects CPI inflation of 5.93 per cent, up from 5.54 per cent in September, near the upper end of the RBI’s 2 to 6 per cent band.
The real test arrives on Thursday, when the inflation numbers land.
