Bond yields to soften further in FY16

The yield on the 10-year bond fell by 107 bps in the previous fiscal (FY15) compared with a rise of 84 bps in FY14

The fall in bond yields is seen to be continuing in the current financial year on the back of a sharp fall in the previous financial year as the Reserve Bank of India (RBI) might cut interest rates further and the US Fed will hike interest rates gradually.

However, this year's fall might not be as significant as the fall in the previous financial year (FY15).

The yield on the 10-year bond fell by 107 basis points (bps) in FY15 compared with a rise of 84 bps in FY14.

“Last year, yields fell in anticipation of repo rate cuts by RBI. Now that anticipation has come down. Earlier the market was expecting repo rate cut of 100 bps out of which 50 bps has already happened. At best, the 10-year benchmark will fall to 7.40 per cent,” said Ashutosh Khajuria, president (treasury), Federal Bank.

Since the start of 2015, RBI has cut the repo rate, or the rate at which banks borrow from the central bank, by 50 bps in two tranches of 25 bps each time. In the first bi-monthly monetary policy of FY16 held earlier this month, the central bank kept the repo rate unchanged at 7.50 per cent.

The existing 10-year benchmark bond (8.40 per cent 2024) will soon be replaced by a new 10-year bond and with a coupon rate lower by at least 15-20 bps from the yield on the current benchmark bond.

The yield on the 10-year benchmark bond ended at 7.80 per cent on Thursday compared with its previous close of 7.78 per cent.

“The two key things to look at are the government's food management policy and the global developments. If the pressure for global competitive easing continues, then that will also have an impact on RBI's decisions. Our base case is for a further 25 bps repo rate cut in 2015 and another 25 bps rate cut in the January-March 2016 quarter. Markets are relatively prepared for the US Fed's rate hikes. The rate hikes are expected to be gradual,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund.

Consumer Price Index (CPI)-based inflation for March eased to 5.17 per cent, the lowest in three months, aided by lower food prices in spite of crop damage due to unseasonal rain.

Retail inflation in February stood at 5.37 per cent.

“Despite the inflation being lower, going ahead RBI is targeting to bring down retail inflation to four per cent. The entire interest rate objective will be set with this objective in mind,” said S Prabhu, head of fixed income at IDBI  Federal Life Insurance.

Prabhu believes the yield on the 10-year bond will bottom out at around 7.50 to 7.60 per cent level this financial year.