Q1 GDP at record high but short of expectations; bond market sees prolonged RBI accommodation

Just three trading days ago, the yield on the 10-year benchmark 6.10 per cent, 2031 bond touched its highest ever intraday level of 6.26 per cent, as concerns over elevated inflation, tightening of global monetary policy and rising supply pressures soured the mood among investors.

Today, the yield on the benchmark 10-year sovereign bond is six basis points lower at 6.20 per cent, implying a rise in price of around 42 paise. Bond yields and prices move inversely.

What has changed on the ground and brought the bulls back to the fore?

Consumer Price Index-based inflation, the Reserve Bank of India’s monetary policy anchor, is around 160 basis points above the central bank’s medium-term target of 4 per cent, while gross supply of government bonds has seen no fresh reduction.

Two key factors have roused bond traders from their recent apathy. First, the central bank’s communication — overt and possibly covert. Secondly, India’s Apr-Jun GDP data, which looks very pleasant on paper, may not be that comforting in reality.

On Tuesday, India reported a record 20.1 per cent expansion in GDP for April-June, the first quarter of the financial year. While it is indeed comforting that the country is back on the growth path after the 7.3 per cent GDP contraction seen in 2020-21 (Apr-Mar), the jump in GDP growth was largely owing to the statistical effect of an extremely low base in the previous year.

According to economists, on a seasonally adjusted sequential basis, India’s real GDP registered a decline of over 12 per cent in April-June. More tellingly, the GDP growth seen in the first quarter fell short of the RBI’s own estimation of 21.4 per cent.

The key takeaway from this is that the central bank, which over the past few months has had to shield questions about elevated inflation, is unlikely to take its foot off the pedal with regard to monetary policy accommodation anytime soon.

While many sections of the market still say the RBI may take fresh steps to rein in surplus liquidity conditions in the banking system in the coming months, the pressure on the central bank to step up vigilance on price pressures has reduced. In fact, it is now possible that for much of the rest of the financial year, the central bank could focus mainly on modulating the amount of excess liquidity rather than narrowing the Liquidity Adjustment Facility corridor through a reverse repo hike, traders say.

The Executive Vice-President and Head of Trading at ICICI Securities Primary Dealership, Naveen Singh, says: “Our growth numbers are not looking like a runaway recovery. We are in for a long-drawn battle. I feel there is one major factor that can push the RBI into a corner and that is the government. The government will ask questions on inflation only when growth is looking much better and they themselves feel that inflation needs correction. The market positioning is favoring taking longs. People are comfortable taking positions because things have changed on the ground level. We are continuously seeing that despite the high inflation, the RBI is not budging. On top of it, the global theme is also favouring bonds. No major central bank is talking in a particularly hawkish way.”

The price action since the GDP data was released bears testament to the market’s confidence in prolonged central bank accommodation.

At 6.20 per cent, the yield on the 10-year benchmark 6.10 per cent, 2031 bond is at a crucial psychological level. While it is hard to predict, there are some in the market who say the bias for the benchmark yield could be towards the downside. One only has to look at the 7-basis-point fall in the yield on the highly liquid 14-year benchmark 6.64 per cent, 2035 bond since last week to notice the change in the market’s perception.

“See the way longer-maturity bonds have rallied over the past week,” a senior treasury official with a large foreign bank says on condition of anonymity. “Firstly, the (RBI) governor said in his latest interview that any action towards normalisation will be very well communicated to the market. Second, he himself said that the tolerance for inflation has gone up within the bounds of the range and, thirdly, he mentioned the latest rise in Covid numbers. All of this points towards accommodation for longer and hence the bond rally.”

Today, fresh Covid-19 cases rose to a two-month high of 47,029 in India, sparking worries about a fresh wave of the deadly disease.

ICICI Securities Primary Dealership’s Singh is of the view that the yield on the 2031 paper could fall to around 6.15 per cent if the fresh daily Covid cases breach 50,000 and stay above that level for some time.

COVERT PUSH?

Last week’s primary auction of government bonds came as a pleasant surprise to the market. Not only did the debt sale go through without having to be partially rescued by underwriters, but the cutoff prices for most bonds were higher than market expectations, indicating a favorable view on dated securities.

Some traders say in recent informal chats, RBI officials had nudged certain banks to bid at aggressive levels at the debt sale. “RBI was communicating all throughout last week, and it shows in the auction,” a bank official says. “It is possible that in the next tranche of RBI OMOs, there could be some papers chosen which could offer those banks a profitable exit. It is possible that the next cutoff for the 10-year bond at the auction could be at 6.20-6.21 per cent.”

The RBI’s next monetary policy statement is in early October. The only key domestic major data set to be announced before that is the inflation print for August. However, if one goes by the latest GDP numbers, it seems the stage is set for the RBI’s oft-repeated line — growth takes priority. The bond market certainly believes so.