India's 10-year bond yields hit two-year high on hawkish RBI minutes

Ten-year bond yields spiked 10 basis points (bps) after minutes of the February 5-6 meeting of the Monetary Policy Committee were revealed by its members on Wednesday. 

This came with the US Federal Reserve cautioning for more rate hikes in the world’s largest economy. 

The 10-year yield touched a two-year high of 7.816 per cent on Thursday, up from its previous close of 7.71 per cent, in intraday trade. It closed at 7.75 per cent on Thursday.

While US policymakers took comfort in rising inflation rate and increased economic growth, Indian policy makers were worried about the recent spike in food prices. 

“Bond yields have been rising for the past few months due to a slew of domestic and international factors. Locally, higher inflation, fiscal deficit overshoot and tighter liquidity in the banking system have been responsible for the bond rout. The MPC minutes also highlighted the worries on inflation,” said Manish Wadhawan, managing director and head of fixed income (global markets) at HSBC India. 

“Internationally, fear of withdrawal of the central bank’s accommodative stance and high oil/commodity prices added to the sell-off,” said Wadhawan.

The minutes showed Reserve Bank of India (RBI) members acknowledging what the bond markets had predicted for long – interest rates had risen in the economy. 

“Fixed income markets are telling us that we have fallen behind the curve,” said Michael Patra in the two-day MPC meeting, minutes showed. In the near term, the inflation rate would likely drift “well above target.” 

“The target is in danger of getting out of reach and over the next few months, the upper tolerance band is under threat. This could seriously dent the credibility of the Committee’s commitment to the target,” Patra said. He also suggested the real policy rate (repo rate minus inflation) was below one per cent and could fall further in the absence of policy action. Which was “completely misaligned with underlying fundamentals and the economy’s prospects at a time when activity is picking up. In view of the prolonged period of status quo, a series of rate increases may be warranted to remove excessive accommodation.”.

RBI Deputy Governor Viral Acharya had almost favoured a change in stance, but said high oil prices could bring back shell producers. This could cool off the oil prices. 

Overall, the approach of the policy was to wait and watch, even as all members were concerned about the rising inflation rate.

The markets saw the minutes as quite hawkish, indicating rate hikes, though the timing was not a given.

“While the MPC’s next move would likely be a rate hike, we did not sense from the minutes that this would be taken up immediately, as recovery was still at a nascent stage,” wrote Morgan Stanley.

Their base case is of a hike in the December quarter. But this could get preceded if inflation flares unexpectedly in the interim, it said.

Meanwhile, US yields rose as the US Fed minutes signalled more possible rate cuts. The Trump Administration’s tax cuts and deficit financing could create an asset price bubble and the Fed wanted to make sure that was checked in advance through faster rate hikes, different commentators said. 

While the US 10-year bond yield jumped to a four-year high of 2.95 per cent after the minutes, the two-year yields hit its highest since September 2008, at 2.282 per cent. Indian bond yields, therefore, would have to increase to reflect the rise in the US, said bond dealers.