Comment :
The hawkish tone in the February policy statement and surprise jump in Inflation in the last month had fuelled an expectation of a rate hike in this policy.
Thus, a ‘no rate hike’ was a positive surprise.
The governor made special efforts to sound hawkish by singling out this rate pause as onetime deviation from its broader monetary policy path. Despite the use of Phrases like ‘for this meeting only’ and ‘a pause not pivot’, the bond market seems to have read it differently. Bond yields fell by around 10 basis points post policy announcement with the 10 year government bond yield falling below 7.2%.
The governor made repeated reference to the potential impact of the effective 290 basis points of rate increases in the last 1 year. They also revised down its inflation forecast for FY24. This indicates that the RBI has probably reached its destination in terms of the level of Repo Rate and will hike rate only if inflation path moves up significantly. The pause also seems to be driven by global financial stability issues.
Going ahead, the bond market will price for extended rate pause with terminal repo rate at 6.5%. This should open up space for Government bond yields to go down. We would expect the 10 year government bonds to trade between 7.00%-7.40%.
At current yield of 7.2%, government bonds are now offering positive real yield of about 200 basis points based on 4 quarter ahead inflation estimate of 5.2%.
Also, with the rate hiking cycle nearing end and inflation trending down, probability of capital gains in long term bonds has increased. Investors with over 2-3 years investment horizon should allocate to dynamic bond funds which tends to benefit in this kind of interest rate environment. Conservative investors with shorter holding period should stick to liquid funds with good credit quality portfolio.
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