Bonds Rally Running Out Of Steam: Report

A two-month rally in government bonds that pushed yields down by as much as 26 basis points on benchmark tenors is running into resistance from inflation concerns and global monetary policy tightening, analysts said.

The yield on India's 10-year benchmark 6.54% 2032 bond has fallen 13 basis points in August, following a similar decline in July, driven in part by expectations of these bonds becoming part of global benchmark indexes and thus attracting strong foreign investment flows.

Yield on that bond, now at 7.19%, had risen for seven consecutive months through June by an aggregate of 112 basis points.

"Bond yields may be at their near-term bottom and once the euphoria regarding index inclusion fizzles out, we may see some uptick in bond yields in September," said Debendra Kumar Dash, senior vice president, treasury, at AU Small Finance Bank.

Earlier this month, Goldman Sachs said it expects inclusion of Indian bonds into indexes, such as the FTSE World Government Bond Index, in 2023 which may trigger inflows of $30 billion, while a media report that JPMorgan is speaking to large investors on adding India to its emerging-market bond index had furthered the bullishness.

"India's inclusion will not only lead to inflows, but also help find buyers for the record bond supply as it will create a new pool of investors," said Nandan Pradhan, deputy general manager, treasury, at Cosmos Bank.

Such foreign buying of government bonds had primarily caused yields to decline in a month in which the Reserve Bank of India hiked rates by 50 basis points.

Foreign investors bought government bonds worth a net 35 billion rupees ($440.28 million) in August, their first monthly purchase since January. They had sold bonds worth around 173 billion rupees in February-June, data from the Clearing Corp of India showed.

RATE HIKE CONCERNS

Traders, however, were concerned with the swift pace of fall in yields, given the bond-inclusion related flows will hit the market only in the next financial year, while other headwinds such as inflation and rate hikes persist.

"There is still no clarity over the terminal repo rate and upside risks to inflation still persist, so it is unlikely that bond yields fall further from the current levels," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

The RBI has raised rates by 140 bps between May and August. The US Federal Reserve has increased rates by 225 basis points since March.

Economists predict the RBI will hike rates by another 60 bps in 2022, but more is likely if the Fed persists with rate rises.

The retail inflation has stayed above the central bank's upper tolerance range of 6% for seven straight months and is expected to ease only in the fourth quarter of the fiscal year ending in March.

Nomura expects inflation to average 6.7% in this fiscal year, with the RBI hiking repo rate by 35 bps and 25 bps in September and December, respectively.