Rate cut impact: Rally in bonds likely to continue in 2015

The bull run in the bond market is seen sustaining in 2015, on the back of interest rate cuts by the Reserve Bank of India (RBI). After the surprise rate cut by the central bank on Thursday, the Street expects a cut of at least another 50 basis points (bps) in 2015, due to comfort on the inflation front and the government’s commitment to adhere to the fiscal deficit target.

“Households’ inflation expectations have adapted, and both near-term and longer-term inflation expectations have eased to single digits for the first time since September 2009. Inflation outcomes have fallen significantly below the eight per cent targeted by January 2015. On current policy settings, inflation is likely to be below six per cent by January 2016,” RBI Governor Raghuram Rajan stated

The yield on the 10-year benchmark bond fell to 7.66 per cent in early trades before closing at 7.70 per cent compared with the previous close of 7.77 per cent. At the start of the current financial year the yields on the 10-year bond had climbed to above nine per cent.

“If we see another 50 bps rate cut, that will result in 10-year bond yield falling to 7.25 per cent. The US rate hikes are discounted by market participants. I do not see that as a cause of concern. Besides, the timing of rate hikes is still unclear,” said Lakshmi Iyer, chief investment officer (debt) and head of product, Kotak Mutual Fund.

The repo rate had remained at eight per cent since the previous rise of 25 bps in the January 2014 monetary policy review of RBI. “Earlier, we had expected RBI to wait for the Budget and then go for the first rate cut. Now that the rate cut cycle has begun, we expect more in the April-June quarter this year. In that quarter, there may be 50 bps rate cut. The cuts then will be in two tranches,” said Radhika Rao, economist, group research, DBS Bank.

Consumer Price Index (CPI) inflation rose an annual five per cent in December compared with a rise of 4.38 per cent year-on-year in November 2014, the slowest pace in data going back to January 2012.

But despite the rise in CPI inflation, it was below market expectations.

The central bank will review monetary policy again on February 3. Another cut in the repo rate on that day looks difficult. “Going ahead, we expect the RBI to cut rates by another 25 bps after the end-February budget announcement. Given the move today, this could well happen in March, between the scheduled meetings of February and April,” said Pranjul Bhandari, chief India economist and Prithviraj Srinivas, economist of HSBC in a note to clients.

In the near term, however, bond yields might not record significant fall.

“The market had already anticipated a rate cut on February 3. The surprise was that the rate cut happened today. Now another rate cut on February 3 may not happen due to which from here the yields may not fall sharply in the near term,” said Ashutosh Khajuria, president (treasury), Federal Bank.