Indian government bonds snapped a four-session falling streak on Tuesday, after the yield rising to a three-year high attracted investors back to the market. The benchmark 6.94% 2036 bond yield ended at 7.3655% against 7.3857% in the previous session, marking a significant recovery from the three-year peak. According to The Economic Times, the Indian bond market experienced a surge as value investors jumped in, increasing demand significantly after hitting a three-year peak. The recovery comes after India's government bond yields have hit a three-and-a-half-year high of 7.39%, primarily due to the central bank's strategy to minimize liquidity, with the 10-year benchmark yield jumping 9 basis points on Monday, its biggest one-day spike in over six months. The rupee outperformed its regional peers and ended 0.5% up against the dollar at 95.28, boosted by new central bank measures to alleviate pressure on the Asian currency.
The RBI's comprehensive liquidity measures announced last week have already begun showing results in money market operations. According to Business Standard, the weighted average call money rate on Monday stood at 5.43% against 5.31% on October 9, representing a 12 basis points increase following the implementation of the new measures. The measures, including moves to increase the daily CRR maintenance limit to 99% and bond sales through open market operations, are designed to help accelerate rate hike transmission. Money market experts noted that high surplus liquidity in the banking system can weaken the transmission of policy rate hikes by reducing banks' dependence on market borrowings and allowing them to meet credit demand using readily available funds. The excess liquidity also keeps short-term money market rates lower, limiting the immediate impact of a policy rate hike on overall borrowing costs.
Indian states raised over ₹300 billion through bonds while the Reserve Bank of India sold notes worth ₹250 billion through an open market operation, with a 340 billion rupee sale of benchmark paper following on Friday. As reported by The Economic Times, this substantial debt supply is creating significant market dynamics as investors await the heavy issuance. The RBI's latest currency market measures have clouded the outlook for banking system liquidity and the impact on banks' treasury operations, which pushed up bond yields. Traders also fear that the central bank will hike rates more aggressively to protect the local currency, after last week's 25 bps increase and change in stance to calibrated tightening from neutral. Meanwhile, traders are awaiting US inflation data due on Wednesday for cues on the Federal Reserve's moves.
September consumer inflation accelerated to 5.54%, exceeding the 5.40% estimate in a Reuters poll, underscoring the risk of more rate hikes in the coming months as Brent crude holds above $105 per barrel. As reported by The Economic Times, Akhil Mittal, senior fixed income fund manager at Tata Asset Management, noted that "FY27 inflation could be in the 5.30%-5.40% range and could further continue inching up in Q1FY28. This reiterates our view of a total 75-100 bps rate hike cycle." The bond market is currently factoring in nearly 100 basis points of repo rate hikes (including 25 bp delivered), so a hawkish signal is not entirely unexpected. The RBI has also raised its FY27 inflation forecast to 5.2% from 5% even as it raised its GDP growth forecast to 7.1% from 6.7%. Bets of a December rate increase have hardened after the inflation data, with the one-year OIS rate ending at 6.3350%, two-year at 6.5150%, and five-year rate settling lower at 6.74%.
Fund houses are implementing significant strategic shifts to manage duration risk amid the current liquidity tightening environment. As reported by The Economic Times, Axis Mutual Fund now prefers one-year to three-year high-quality corporate bonds, where favourable carry, ample liquidity and limited issuance of banks' certificates of deposit create an appealing opportunity. Aditya Birla Sun Life AMC likes the ultra-short term debt, while Bandhan Asset Management has slashed its weighted average bond duration to less than a year, from around 12 years. Subhendu Harichandan, Executive Director at Anand Rathi Wealth, noted that while there can be pressure on NAVs of debt funds in the short term, short- and medium-duration funds are in a better position to reinvest at new, higher rates. The fund houses are moving to ultra-short duration assets across government and corporate debt while selling long duration government bonds, with Axis Mutual Fund indicating it may tactically add duration only when the rate-hiking cycle progresses and yields become more attractive.
