Where’s bond market headed?

By staying pat on rates and indicating its cautious stance on inflation and hardening of global bond yields, the RBI has tempered down bond market expectations.

The Indian bond market that was pricing in a rate cut on Wednesday, corrected, with the yield on 10-year G-Secs moving up nearly 20 basis points to 6.4 per cent. Going ahead, we expect yields to hover in the 6.2-6.4 per cent range, amidst a likely tug of war between global and domestic factors.

Bond markets have had a lot to cheer in 2016, with yields on 10-year G-Secs falling sharply by nearly 1.5 percentage points since the beginning of the year.

The RBI’s decision to move to a neutral liquidity scenario in the April policy by conducting open market operations (OMOs) — buying of government bonds — helped yields move lower. The Centre’s demonetisation move has been yet another shot in the arm for bond markets.

The aggressive buying of government securities by banks flush with funds, has led to a sharp fall in yields of about 50 basis points over the past month. Public sector banks have been net buyers to the tune of around ₹44,260 crore while private banks have bought around ₹5,100 crore of government securities over the last three weeks.

A mix of domestic and global factors are likely to weigh on the bond markets from hereon. There will be continuous demand for G-Secs by banks because of infusion of fresh deposits in the system. This will push up prices and yields lower.

The roll-back of CRR hike (on Wednesday) that was introduced by the RBI post-demonetisation, has also come as a relief for bond markets.

However, the RBI will likely wait for more clarity on the US Fed rate action, demonetisation impact and inflation trajectory before cutting rates further. This can limit a rally in bond prices.

Global yields hardening can also leave little headroom for a fall in yields in the domestic bond market. The spread between the US’ and India’s 10-year benchmark bonds has been shrinking over the past couple of months.

With US bond yields currently at 2.4 per cent levels, the spread is around 400 basis points. A hike in US rates can lead to outflows from India’s bond markets, adding pressure on bond prices.

So, what should bond investors do now?

Given that the bond rally will be limited for the rest of the year, investors who have already invested in gilt funds can take some profits off the table. For those sitting on the sidelines, it would be wise to invest in short-term debt funds that carry lower volatility.