Why an inflation dip may not be good news for India's bond traders

Traders in India’s battered bond market would do well to take any potential easing in inflation with more than a pinch of salt.

A report Wednesday may show price pressures in August eased below 4 per cent for the first time in 10 months. While that sounds like good news, a currency that’s been slipping to a new record almost every day is ensuring that the optimism doesn’t last too long. The benchmark bond yield climbed to its highest level since 2014 this month.

“The worst is still to come” for bonds, with risks to inflation rising because of the rupee and leading to expectations of a steeper increase in interest rates, said Naveen Singh, head of fixed-income trading at ICICI Securities Primary Dealership Ltd. in Mumbai. “A lower CPI reading is not going to make a meaningful impact on bonds.”

Losses in the rupee -- Asia’s worst performer in 2018 -- have accelerated amid fears of an emerging-market contagion. The currency has slipped almost 5 per cent since end-July, a decline that has the potential to add 15-20 basis points to retail inflation, according to estimates from Edelweiss Securities Pvt. The brokerage also reckons that every $10/barrel rise in crude oil boosts CPI by 30-35 basis points.

India’s benchmark 10-year sovereign bonds have slumped in six of the last eight months, hurt also by fears of an increase in government borrowings before the 2019 national elections and an emerging-market rout that’s seen foreign funds dump local debt.

The 10-year yield may climb to as high as 8.25 per cent by end-September if the government -- which is seeing revenue collections falling behind -- decides to add back the 500 billion rupees ($7 billion) of borrowing that it had slashed earlier this year, according to Singh.

“It’s highly likely,” he said.

The Reserve Bank of India in June raised interest rates for the first time since 2014 and tightened again in August. Commerzbank AG is already flagging the possibility of two more increases this year, which would only add to the misery of bond traders.

Below are the key Asian economic data and events due next week:

Monday, Sept 10: Japan 2Q GDP and July trade balance; China CPI and PPI

Tuesday, Sept 11: Australia ANZ Roy Morgan consumer confidence index and NAB business conditions for Aug.; Philippines July trade balance

Wednesday, Sept 12: India Aug. CPI and July industrial production; Australia Westpac consumer confidence; Singapore retail sales; South Korea unemployment

Thursday, Sept 13: Japan Aug. PPI; New Zealand Aug. food prices; Australia jobs

Friday, Sept 14: Business NZ manufacturing PMI; China retail sales and industrial production; Japan industrial production; India wholesale prices