Commercial banks are set to make trading gains as the yield on the benchmark 10-year government bond fell 19 basis points in April-June quarter to settle at 7.12% on the last trading day of the first quarter.
Banks faced a staggering notional loss of Rs.71,817 crore during 2022-23, should they choose to mark to market all bond portfolios, including their held-to-maturity (HTM) holdings, according to the financial stability report by the RBI. The amount is one-third of the total profit reported by the banks in 2022-23.
Bond yields went up sharply in the last financial year on the back 250 bps hike in policy repo rate by RBI,
However, the first quarter of the current financial year was full of optimism for the government bond market.
“There should be some reversal for banks,” a dealer at a state-owned bank said. “But it depends because in the last 15 days yields have risen again, however, there should be some amount of reversal.”
The bond yields inched up by 6 basis points on Friday due to rise in US Treasury yields, and lower than expected cut-off at the Rs 33,000 crore. “The cut-off on the 10-year paper (benchmark 7.26%,2033 bond) was not even at the market level, I see the yield (on the 10-year paper) to inch up to 7.14-7.15 percent level from here,” a dealer at another state-owned bank said. “This is because the positive sentiment has started to waver off; there is nothing positive in the market right now.”
Meanwhile, the yield on the benchmark 10-year US Treasury note rose by 13 basis points to a three-month high of 3.85% on Thursday as recent data indicated the US economy strengthening, thereby, firming the expectation of a rate hike by the US Federal Reserve.
The yields on the domestic government bonds fell in Apr-Jun quarter due to the overall positive market sentiment after the Monetary Policy Committee decided to keep the repo rate unchanged at 6.50%, in its meeting on Apr 6.
The domestic rate setting-panel paused the rate hike cycle after six consecutive rate hikes aggregating to 250 basis points since May 2022, thereby prompting traders to stock up on government bonds betting that the committee’s next action would be a rate cut.
On May 13, the yield on the benchmark 10-year bond settled below 7% mark for the first time since April 2022.
Moreover, the headline consumer inflation moderated to 5.66% in March, falling within the target band of the Reserve Bank of India, and lowest since Dec 2021. The RBI’s inflation target is 4%, with a tolerance band of two percentage points, both above and below the target. After briefly reaching the target range in March, India’s consumer inflation has been declining, and it reached a 25-month low of 4.25 percent in May.
However, dealers believe that market participants went overboard with expecting rate cuts as early as October.
“Certainly market went overboard as the data was not there, and the RBI’s expectation about tackling inflation was different from what the market was looking at,” Naveen Singh, head of trading & EVP at ICICI securities primary dealership said. “The RBI is not okay with inflation just being within the tolerance band; rather they wanted to be close to four percent or sub-four percent.”
The market sentiment took a turn after the RBI Governor Shaktikanta Das confirmed in his post policy speech in June that the rate-setting panel is aiming to achieve the 4% inflation target, and would continue the withdrawal of accommodation stance.
Additionally, the US Federal Open Market Committee signaled more rate hikes in the current calendar year, even though the US rate-setting panel kept the interest rates unchanged at 5-5.25 per cent, in its June meeting.
As a result, the rate cuts expectations got pushed to February or the first quarter of the next financial year, signaling a significant departure from traders’ initial expectations of a possible rate cut in as early as October.
“While the expectation varies from person to person, there was a broad expectation that by the end of the current calendar year, there will be a rate cut by RBI,” Vijay Sharma, Senior executive vice president at PNB Gilts primary dealership said. “Now, after some hawkish statements from the last policy, people have taken the expectations of a rate cut ahead by three months. Now the market is expecting a rate in the first quarter of the next calendar year. The stronger than expected US economic data has also played its role in this development”
Moving forward, dealers expect the global factors to weigh on the government bonds. Traders will now be looking at global cues for further guidance as the domestic-rate setting panel is expected to keep the repo rate unchanged for at least the current calendar year, dealers said.
“Global factors are not supportive right now, as central banks across globe have been hiking rates, they had paused earlier but they are hiking again because the data has not changed to an extent they wanted to,” Singh said.
“The situation for bonds is pretty tricky; we might see some pressure building, to all the way say until 7.50% (the yield on the benchmark 10 year govt bond)”.
On the domestic front, cooling consumer inflation might keep the government bonds afloat for the current calendar year, dealers said. The market participants have also already priced in the increase in supply in July-Sep, which means there might be little to no effect on the government bonds.
However, dealers expressed concerns about the potential impact of the El Nino weather phenomenon on agriculture output and incomes.