The future course of bond yields will depend on the quantum of rate hikes and on the tone of the Reserve Bank of India (RBI) in the policy statement tomorrow.
A 50 basis points (bps; 100 bps make a percentage point) rate hike with a dovish tone will lead to a rally in the ten-year bond yield (the 7.80% 2021 government bond is trading at 8.13% levels) with yields coming off by 10-15 bps.
A 25 bps rate hike with a dovish tone will lead to a 30-35 bps rally.
A 50 bps rate hike with a hawkish tone will take up bond yields by 10-15 bps, while a 25 bps rate hike with a hawkish tone will bring down bond yields by 5-10 bps. Hence, the only bearish scenario is a 50 bps rate hike with a hawkish tone.
A dovish tone is when the RBI talks about tempering rate hikes going forward and talks about inflation expectations coming off. The apex bank has raised the benchmark repo and reverse repo rates by 200 bps and 250 bps, respectively, over the last one year.
It may suggest that rates hikes after the current policy rate hike may depend on the effect of monsoons and on the effect of global commodity prices on economic growth.
Both the factors are out of its control and if economic growth is looking to suffer from such factors, the RBI may temper their policy stance.
Inflation expectations are trending higher on the back of March inflation numbers coming a percentage point above the RBI’s forecasts. Inflation as measured by the WPI (Wholesale Price Index) came in at 8.98% for March against the RBI’s expectations of 8%.
The sharp rise in oil prices with brent crude trading higher by over 30% year to date is also giving rise to rising inflation expectations.
The RBI may suggest that inflation expectations are likely to come off on the back of earlier policy actions coupled with the strong rupee negating a part of the rise in oil prices. India imports 70% of its oil requirements and a rising rupee benefits the country as oil imports become cheaper.
The rupee is trading at one year highs against the dollar on the back of the US Federal Reserve keeping rates at all time lows while RBI and other central banks have raised rates to counter rising inflation expectations.
A hawkish tone is when the RBI talks about further rate hikes ahead and about rising inflation expectations. By signalling further rate hikes, it may suggest that current policy measures have not contained rising inflation expectations and that more measures are required.
The RBI may become hawkish on the back of high oil prices as well as on the fact that the government is still subsidising. This understates inflation and the central bank has to compensate through monetary actions.
The RBI may also talk about monsoons impacting food prices and if food price inflation trends higher on supply disruptions, it may look at it negatively.
The RBI will also give forecasts for 2011-12 deposit growth, credit growth and money supply.
In the context of the current policy stance, the RBI is likely to target deposit growth of 18%, credit growth of 18% and money supply (M3 or broad money) at 17%. The previous fiscal’s growth was 15.8%, 21.4% and 16%, respectively.
Slower credit growth target will bring down inflation expectations, while higher deposit growth and money supply target will improve liquidity in the system.
The RBI is more likely to raise rates by 50 bps and adopt a dovish tone. The 50 bps hike will send
a strong signal on RBI’s intention to control inflation expectations
as well as helping the rupee
appreciate.Turn to Page 10
A 50 bps hike = bond rally, 25 bps = even bigger rally
The fact that countries such as China and Brazil have seen their currencies touch multiyear highs on the back of their central banks raising rates to contain inflation will influence RBI’s decision.
Once the hike is done the RBI will tone down its policy stance on expectations of their monetary measures working on the system.
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