Bond yield rises to 4-month high; OIS market discounts rate cut by Dec

Selloff continues despite retail inflation hitting 8-year low

Government bond yields surged by another 5 basis points (bps) on Tuesday as stop-losses were triggered, prompting heavy selling likely led by mutual funds. Dealers said the rise was also weighed down by higher-than-expected cut-off yields at the weekly state development loan (SDL) auction.

 

The benchmark 10-year government bond yield closed at 6.49 per cent — its highest level since April 3 — compared with the previous close of 6.44 per cent.

 

The selloff in the bond market continued despite retail inflation hitting its lowest level in eight years last month. On Monday, the yield on the 10-year benchmark bond had risen by 3 bps.

 

Traders said the relief from softer inflation would be short-lived, given the Reserve Bank of India’s (RBI’s) projection of a sharp pickup in inflation in the first quarter of the next financial year. The RBI has forecast CPI inflation at 4.4 per cent in Q4 of FY26 and 4.9 per cent in Q1 of FY27, dampening expectations of further rate cuts.

 

Market participants said Tuesday’s selling was likely triggered by stop-losses, mainly from mutual funds, and compounded by the higher-than-expected SDL cut-off yields. 

 

“The market perceived the monetary policy committee (MPC) stance as a hawkish pause rather than the expected dovish pause or hawkish cut. This killed any hope of a rate cut in the coming months. On top of that, more than Rs 50,000 crore of central and state government bonds are hitting the market every week,” said Vijay Sharma, senior executive vice-president at PNB Gilts. “With investment and trading books already under stress, the capacity to absorb fresh issuance is shrinking. There’s no expectation of further open market operations from the RBI, so buyers are reluctant to step in,” said Sharma. The biggest puzzle, he said, is that Overnight Interest Swap (OIS) is pricing in at least one rate cut, while the bond market is behaving as if a hike is coming. “In the end, it all comes down to demand and supply, and right now, supply is overwhelming a market that’s already under strain,” he added.

 

While the benchmark bond yield has risen 12 bps so far in August, the five-year OIS rate has fallen 5 bps.

 

OIS rates indicate expectations of at least one rate cut by the MPC before the end of the calendar year. This expectation is driven by factors such as easing inflation and concerns over economic growth, especially on Indian exports due to recent US tariff measures.

 

However, some market participants believe the decline in OIS rates may be more related to expectations of falling US Treasury yields rather than an imminent rate cut by the RBI. They suggest this trend is primarily driven by offshore activities, particularly in response to the US imposing a 50 per cent tariff on certain Indian goods.