Bond bulls bet on RBI's dovish turn to extend rally amid policy shift

While interest-rate swaps are pricing a rate cut only in December, traders are girding for a possible shift in the RBI's stance to neutral

By Subhadip Sircar

India’s bond bulls are optimistic the central bank will ease its hawkish monetary policy stance, potentially setting the stage for the next leg of a rally. 

While interest-rate swaps are pricing a rate cut only in December, traders are girding for a possible shift in the Reserve Bank of India’s stance to neutral on Wednesday. They are also closely watching for any dovish signals in the authority’s commentary.

“We are definitely expecting a softer language from the RBI even as the possibility of a stance change remains evenly balanced,” said Pankaj Pathak, a fixed-income manager at Quantum Asset Management Co. “That can be the trigger for a down move in yields.”

The 10-year yield, down 34 basis points this year to 6.83 per cent, may fall further to 6.25 per cent by March, according to Nomura Holdings Inc., with IDFC First Bank predicting a drop to 6.50 per cent. A continued decline may lower borrowing costs for the government, which aims to reduce the budget deficit to a five-year low this fiscal year.    

Indian bonds are among Asia’s best performers this year thanks to over $16 billion of foreign inflows spurred by the inclusion into JPMorgan Chase & Co.’s emerging-market index. 

Bonds have also rallied on bets that slowing economic growth and the 50-basis point rate cut by the US Federal Reserve last month may prompt the RBI to follow. Headline inflation staying below the RBI’s 4 per cent target for two straight months has supported expectations for a dovish policy change.

“The October meeting will be the first MPC meeting this year where at least part of the market expects a rate cut, or a change in stance,” Barclays Plc economists including Shreya Sodhani wrote in a note. That “makes it a relatively exciting meeting,” she said. 

Still, the RBI may proceed with caution amid a resurgence in tensions in the Middle East, which pushed up benchmark yields to near a one-month high on Friday. Governor Shaktikanta Das reminded markets in September that he was in no hurry to reduce borrowing costs.

The RBI’s newly appointed monetary-policy panel is expected to keep the policy rate unchanged at 6.50 per cent for the 10th straight meeting, according to the majority in a Bloomberg survey of economists.  

Analysts are still rooting for a dovish-policy tilt. Rate swaps are pricing in about 70 basis points of rate cuts over the next 12 months with a fair chance of a reduction in December, according to Nomura. 

“The next leg of the bond rally can stem from either a dovishness in the monetary policy and/or stronger foreign inflows,” said Nitin Agarwal, head of India trading at Australia and New Zealand Banking Group Ltd. If investors gain more confidence about global soft landing, it will spur more inflows into EM markets, including India, he said.