Bond yields rise, rupee strengthens a day after monetary policy

Bond yields have started moving up after the Reserve Bank of India (RBI) tightened its rate corridor on Thursday. 

Some market participants said they expect the 10-year yields to touch 7 per cent from the Friday close of 6.81 per cent. As yields rise, prices of bonds fall.  The rupee, meanwhile, continued to strengthen and rose to a 20-month high, as the dollar remained largely stable, despite geo-political tensions in Syria. Foreign investors continued to buy local equities and bonds. 

This is because even with ample liquidity around, short-term rates have started inching up and the RBI’s policy language indicated that chances of rate cuts in the coming months were slim. 

The Reserve Bank of India (RBI) kept the repo rate unchanged but hiked the reverse repo rate by 25 basis point. When liquidity is ample, the reverse repo rate (the rate the central bank pays to banks to absorb liquidity) becomes the operative one. 

A rise in operative rate should have the impact of a rate increase, said bond dealers. Therefore, bond yields should soon reflect that. 

Also, RBI’s guidance on inflation being on the higher side and beyond the comfort zone would be a dampener for the bond market, as these could push the central bank to raise rates. However, some market participants said bond yields might not rise sharply as there were mitigating factors. 

Harihar Krishnamurthy, head of treasury at First Rand Bank, said bond yields were correcting from a recent rally, when the 10-year yields fell to 6.65 per cent level. “There was no tangible reasons for that movement, so a correction was due.” However, foreign investors’ interest in emerging market debt papers would keep the yields under check, he added. 

Foreign investors have this year put about $5.35-billion-equivalent in the Indian debt market. Plus, the comfortable liquidity situation would continue to boost bonds, he said, adding the 10-year bonds should not cross 6.90 per cent in the near future.  IDFC Bank, in a report, said clarity on liquidity management also kept the yields under check and should be around 6.90 per cent for the first half of this financial year. 

The rupee, meanwhile, would continue to strengthen and this has led to exporters selling huge amount of dollars in the forwards market, leading to forward premium collapsing around 0.50 per cent in the past two days. The rupee rose to a 20-month high against the US dollar, closing at 64.28, from its previous close of 64.51 a dollar.