Short-term rates at near three-year high

Ahead of the Monetary Policy Committee (MPC) meet next week, short-term yields are spiking. On Wednesday, the yield on the one-year T-bill hit 6.08% at the Reserve Bank of India’s (RBI) auction. These are the highest levels since July 2019 and at nearly three-year highs.

Yields at the shorter end of the curve had risen in April after the RBI introduced the Standing Deposit Facility (SDF), as the effective floor of the LAF corridor. At 3.75%, the SDF was 40 bps higher than the reverse repo rate of 3.35%, in a move considered a stealth rate hike.

Meanwhile, as bond markets brace themselves for another 40 bps hike in the repo rate, the yield on the benchmark inched up to 7.433 on Thursday, up 2 bps. The recent high was 7.47% on May 9, after the MPC opted to hike the repo by 40 bps on May 2. Five-year paper also lost some value as the yield went up by 2 bps to 7.23%.

It has been evident since early May that the MPC will choose to front-load the rate hikes rather than pace itself. The first milestone is 5.15% which is where the repo was in February 2020, before the pandemic. The consensus believes there will be a 40 bps hiked in June followed by another raise of 35 bps in August. Thereafter, the pace of the hikes would depend on inflation forecasts; while some economists are looking at a terminal repo of 5.5-5.75%, though there are some who believe it could cross 6%.

“Given the government’s large borrowing programme, it is unlikely the central bank would be looking at a terminal repo rate of more than 5.5%,” the treasurer of large bank said.

RBI governor Shaktikanta Das confirmed in a recent interview there would be more rate hikes at the next few meetings; it was ‘no brainer’, he said. However, it is unlikely the narrative from the central bank would be unduly hawkish, say dealers, as that would sour the sentiment.

While reviewing monetary policy in April, the central bank said it was prioritising inflation concerns over growth and had upped the inflation forecast by 120 bps to 5.7%. However, that is likely to be pushed up further and the revised forecasts for the current fiscal will be keenly watched. A sharper-than-expected rise in the forecast will send yields shooting up. The markets are not expecting any OMOs (Open market Operations) immediately. The central bank, they feel, would not want to appear over-concerned. Moreover, they point out the RBI would want to wait for a few months to take stock of geopolitical events and global crude oil prices.

Meanwhile, companies are borrowing heavily in the corporate bond market with a view to lock into lower interest rates. Bloomberg reported approximately Rs 8,330 crore has been mopped up in the last three days and that another Rs 8,590 crore is likely to be raised before the week is over.