10-year bond yield hits 3-year high as inflation rises, rupee at 15-month low

Mumbai: The yield on government bonds surged for the fifth consecutive session on Tuesday to hit a three-year high after higher-than-expected inflation data increased prospects of a rate hike by the Reserve Bank of India (RBI) earlier in the year.

At 9.15am, the 10-year bond yield was at 7.903%—a level last seen on 18 May 2015, up 7 basis points from its previous close of 7.825%. Bond prices and yields move in opposite directions.

Meanwhile, the rupee opened at a fresh 15-month low against US dollar. The home currency was at 67.69 a dollar, down 0.26% from its previous close of 67.52.

Consumer price index (CPI)-based inflation rose 4.6% in April, faster than the 4.4% of Bloomberg consensus. Wholesale price index (WPI)-based inflation shot up 3.18% in April from a year ago, higher than 2.9% median estimate in a Bloomberg survey of 28 economists.

“These factors validate our expectations for the RBI policy committee to veer towards a hawkish stance in June (small probability of a pre-emptive hike) and pave the way for a 25bp increase in August. With another move likely in 4Q18, we see room for cumulative 50bp hikes in FY19. Slow progress on the banks’ bad asset resolution and a gradual turnaround in growth suggest that an aggressive hiking cycle is unlikely” said Radhika Rao economist at DBS Bank.

Analysts also fear that the government may not be able to stick to its fiscal deficit target for the year due to a surge in crude oil prices and expectations that it may adopt populist measures ahead of the general election next year.

Bond markets are already under pressure due to continued selling by the foreign investors and after RBI failed to sell all the shorter-maturity government bonds in the weekly auction for the fourth time in a row last week.

On Friday, central bank sold only Rs81 crore of 2022 maturity government bonds out of the Rs3,000 crore on offer. The remaining amount was devolved on primary dealers, underwriters of government debt.

Recent “data will push the central bank to switch to an accommodative policy and deliver a rate cut by December, but given what’s happening with oil prices and the RBI’s hawkish bias, there is an evolving risk that the central bank could tighten policy by August with a one-and-done hike”, said Abhishek Gupta economist at Bloomberg.

So far this year, rupee weakened over 5.5% while foreign investors have bought $671.50 million and sold $3.21 billion in equity and debt markets, respectively.