Bonds recoup losses after inflation shock as long-term players step in

After weakening sharply in early trade due to an unexpectedly high inflation reading, government bonds reversed most losses and ended steady as long-term investors stepped up purchases at what they considered to be lucrative yield levels, dealers said.

Yield on the 10-year benchmark bond closed at 7.37 per cent, versus 7.36 per cent at previous close. In the first hour of trade, yield on the bond had breached the psychologically significant 7.40 per cent level, climbing to a high of 7.41 per cent. Bond prices and yields move inversely.

Given that sovereign bonds are the benchmarks for pricing other credit products, a rise in government bond yields implies higher borrowing costs in the economy.

Data released after trading hours on Monday showed that India’s Consumer Price Index inflation shot up to a three-month high of 6.52 per cent in January versus 5.72 per cent in December. Consequently, the price gauge has again slipped out of the Reserve Bank of India’s tolerance band of 2-6 per cent.

The market expectation for the January CPI print was around 5.9 per cent. More worryingly for bond traders, core inflation, which strips out the volatile components of food and fuel, remained stubbornly above the 6 per cent mark.

The RBI has since December emphasised the importance of bringing core inflation down even as the headline inflation print has showed signs of moderation. The latest inflation data has, therefore, left bond traders fearing another rate hike by the RBI at its next policy review in April. The central bank has raised the repo rate by a total of 250 basis points since May 2022. The repo rate is currently at 6.50 per cent.

“Retail inflation jumped up to 6.52 per cent in January, surpassing market expectations by a mile…while core inflation (6.6 per cent vs. 6.4 per cent in December 22) also inched up in the month. This print reaffirms our view that the RBI is likely to raise rates again in its April policy with no change in stance likely. The bond market could come under pressure,” HDFC Bank’s treasury research desk wrote.

At current levels, overnight indexed swap rates, which are a direct reflection of interest rate expectations, suggest another 25 bps hike by the RBI. The one-year OIS rate settled at 6.90 per cent on Tuesday, indicating a terminal repo expectation of 6.75 per cent, traders said.

Long-term demand

While the inflation data took its toll early on in the day, the 10-year benchmark paper headed back towards its previous levels later on, with heavy buying witnessed once the yield on the paper sustainably broke past the 7.37 per cent mark.

Dealers said long-term investors had shown robust appetite for bonds at those levels, based on the view that policy rates are not likely to go up much further from their present levels.

Naveen Singh, head of trading at ICICI Securities Primary Dealership, said: “7.40 per cent is considered to be a good yield; there is strong demand around those levels from the same set of long-term investors who have shown firm appetite all throughout the current financial year.”

“Yes, the inflation data was negative but the market is more or less convinced that at the most there will be only one more rate hike of 25 bps and that too depends on how conditions play out. We saw good demand at today’s state bond auction too, that shows the investor interest,” he said.

On Tuesday, 11 state governments raised Rs 11,900 crore through the sale of bonds.