As repo rate rises 50 bps, bond markets keep the faith

8 Jun 2022 , 01:48 PM

Investors’ bond portfolios are usually wreaked by policy rate hikes, which often result in a rapid spike in bond yields. However, the bond market has reacted negatively to the Reserve Bank of India’s announcement of a 50-basis-point rise in its repo rate, which was accompanied by enough hawkishness on inflation.

After RBI Governor Shaktikanta Das finished his virtual policy speech, 10-year government bond yields fell about 8 basis points to 7.45%. Bond yields move in the opposite direction of prices, implying that a rise in yields lowers the value of bond holdings.

Four-year bond yields fell 12 basis points, while three-year bond yields fell 9 basis points and two-year bond yields were wiped off by almost 14 basis points.

The move is quite counterintuitive for the retail investor to say the least. Let’s take a look at some of the factors that led to this outcome:

• Bond investors were reassured by the RBI’s willingness to take steps to guarantee that the government’s market borrowing went through without a hitch. This could indicate that the central bank is willing to take steps to lower the government’s borrowing costs by lowering yields.
• This year, the central government plans to borrow Rs14.31 lakh crore from the domestic bond market, with Rs8.5 lakh crore coming in the first half of FY23. Another plus was the lack of an increase in the cash reserve ratio (CRR).
• A CRR increase would have sucked liquidity out of the market, causing rates to skyrocket. Because bonds are fungible, a decrease in liquidity has a bigger influence on yields than a rate hike. As a result, the 50-basis point repo rate hike was nearly priced into bonds.