Bond yields may fall sharply by end-Dec on rate cut hopes in 2015

Experts believe yield on 10-year paper will move to 7.80-7.85% by end-December, from 7.97% currently

While government bond yields have not have moved much since the Reserve Bank of India (RBI)’s monetary policy review on Tuesday, yields might move down by end-December on softer inflation numbers and demand for bonds in anticipation of interest rate cuts in 2015.

The yield on the 10-year bond ended stable at 7.97 per cent on Thursday compared to the previous close. The yield had ended at the same level on December 2 when RBI announced the monetary policy review. According to experts, the yield is moving towards 7.80-7.85 per cent by the end of this month.

“We expect the November consumer price index (CPI)-based inflation at 4.5 per cent. The inflation numbers will give a fillip to the bond market. The demand for bonds is going on with an expectation that we are entering a rate cut cycle. It is aided by low credit growth and easy liquidity in the system. There is an expectation that there will be at least 50 basis points repo rate cut in the next six months,” said Manish Wadhawan, managing director and head of interest rates at HSBC India.

Retail inflation softened to 5.52 per cent in October, the least since the index was created in early 2012, owing to a sharp fall in oil prices.

RBI has revised down the CPI-based inflation target to six per cent for March 2015. Earlier, the central bank’s target was to bring down CPI-based inflation to eight per cent by January 2015.

“A change in the monetary policy stance at the current juncture is premature. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle,” said RBI governor Raghuram Rajan in the monetary policy statement on Tuesday.

The repo rate was last increased by 25 basis points in the January monetary policy review to eight per cent. Rajan left the rate unchanged at eight per cent on Tuesday.

“The yield on the 10-year bond may trade between 7.85 to 8 per cent by end-December. A rate cut by RBI can happen anytime between the Budget and the April policy review. The rate cut can be between 25 and 50 basis points,” said Suyash Choudhary, head (fixed income) at IDFC Mutual Fund.

Not many believe the 10-year bond yield will end calendar year 2014 at a level lower than the current one. “The rally in bond markets will continue because the central bank took a dovish stance in the policy and there are expectations in the market that a rate cut may happen sooner. By end-December, the yield on the 10-year bond may drop to 7.8 per cent,” said N S Venkatesh, executive director and head of treasury at IDBI Bank.