Government bonds, rupee weaken post higher than expected US inflation data

Now that rate cut expectation in the US is getting postponed. The market's expectation for the Reserve Bank of India (RBI) to ease its liquidity stance is also experiencing delays

Government bonds and the rupee weakened on Wednesday after the higher-than-expected US CPI data for January, which came in at 3.1 per cent, against the expectation of 2.9 per cent.

The 10-year benchmark government bond yield settled at 7.11 per cent, against 7.10 per cent on Tuesday. The rupee settled at Rs 83.03 per dollar, against Rs 83.01 on Tuesday.

The Indian currency weakened to 83.11 during the day. However, it recovered by the end of trade on the back of inflows. The benchmark bond yield rose up to 7.13 per cent during the day.

“The rupee experienced volatility, opening lower at 83.09, down by 10 paise, following higher-than-expected CPI data. However, the Indian capital market staged a strong recovery, with banking stocks rebounding by 2 per cent, particularly state-run banks, providing solid support to the rupee. Broadly, the rupee's range continues between Rs 82.80 and Rs 83.30 a dollar,” said Jateen Trivedi, VP Research Analyst at LKP Securities.

The yields on government bonds of shorter tenures rose more as compared to longer tenure bonds because of liquidity deficit within the system, said market participants.

The liquidity deficit in the banking system stood at Rs 2.04 trillion on Tuesday, according to data by the Reserve Bank of India (RBI).

“Now, that rate cut expectation in the US is getting postponed. The market's expectation for the RBI to ease its liquidity stance is also experiencing delays. People feel that RBI will continue to provide only bare minimum liquidity and not let excess liquidity soar in the system,” said Naveen Singh, vice-president of ICICI Securities primary dealership.

Banks submitted bids amounting to Rs 1.1 trillion, against a notified amount of Rs 25,000 crore at the 2-day variable rate repo (VRRR) auction conducted by the RBI to infuse liquidity in the banking system.

The probability of a rate cut by the US Federal Reserve in March dwindled to less than 10 per cent, while the likelihood for May fell to approximately 30 per cent as US inflation data demonstrates resilience. Expectations of rate cuts have now been shifted to June, said market participants.

US Treasury yields increased by up to 17 basis points (bps), while the dollar index rose to a three-month high of 104.96. On the domestic front, the overnight indexed swap (OIS) rate curve is indicating a repo rate cut starting August, said market participants.

“The OIS curve is showing a 20 bps rate cut in August, and if things get worse, then a full rate cut can occur in October,” said a dealer at a primary dealership.

Meanwhile, technical resistance is seen at the 7.15 per cent yield level on the benchmark bond. Market participants speculate that it could require another round of disappointing data to propel the US yield level to 4.50 per cent. Such an occurrence may potentially breach the technical yield threshold on the domestic government bond.