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Indian Bonds Shrug Off Hot Local And Global Inflation Prints

A cocktail of domestic factors have kept government bond yields stable, despite higher inflation prints

<div class="paragraphs"><p>Photo by rupixen.com/Unsplash</p></div>
Photo by rupixen.com/Unsplash

Valentine's week and high inflation don't typically mix well. But for the Indian bond market, Feb. 13 and 14 passed through without causing much of a hiccup—despite inflation's unwelcome surprise.

On Feb. 13, government data indicated that India's retail inflation jumped to a three-month high of 6.52% in January and strayed outside the Indian central bank's tolerance zone. While this could have led to a jump in bond yields, India's 10-year government bond yield closed the day flat at 7.36%.

Similarly, the 30-year bond yield closed the day up by 1 basis point to 7.43% on Feb. 13 as compared to 7.42% on Saturday, Feb. 10.

"The market is slightly ahead of the curve," Ajay Manglunia, head of the investment grade group at JM Financial, told BQ Prime. Market participants have taken into account the hawkish message from central bankers and are largely comfortable with how inflation is being tackled, he added.

"Headline inflation has moderated with negative momentum in November and December 2022, but the stickiness of core or underlying inflation is a matter of concern," Shaktikanta Das, governor of Reserve Bank of India, said in a speech on Feb. 8, while announcing that central bank had decided to hike rates by another 25 basis points.

"Monetary policy will continue to be agile and alert to the moving parts in the inflation trajectory to effectively address the challenges to the economy," Das said.

Additionally, demand for long-dated bonds has stayed pretty buoyant with insurance companies being active buyers over the last few weeks, according to an executive at a primary dealership, who spoke on the condition of anonymity. 

Overall demand has been the driving factor for bond yields but the 10-year bond in specific may have had had yields suppressed further due to demand linked to a bond issuance by Housing Development Finance Corp. Ltd., this executive said. 

On Thursday, Housing Development Finance Corp. raised Rs 25,000 crore via the issuance of 10-year non-convertible debentures in India's largest private bond sale. As part of the sale, HDFC also intends to execute total return swaps to hedge some of the interest rate risk. Total return swaps are agreements under which one party pays the other on a set rate—such as a government bond—while the other one makes payments on the basis of returns earned by underlying assets.

The swaps will create additional demand for 10-year government bonds which can keep yields muted. People are either already buying the bond or waiting to buy it after the issuance, the executive quoted above said. 

The bond market also took India's inflation number with a "pinch of salt," according to Aditya Gore, head of international coverage at Nuvama Fixed Income Advisory. 

Following the negative surprise in India's CPI print, the United States reported retail inflation of 6.4% in January. With inflation continuing to run hot in the United States, U.S. government bond yields rose on the inflation number with the 10-year rising by around 3 basis points to 3.75% on February 14. It jumped another 5 basis points to 3.80% on February 15. 

The 30-year U.S. bond yield also increased by 5 basis points to 3.80% on February 15, as compared to February 14. While yield on U.S. government debt rose, Indian bonds saw a softening in yields.

The yield on the 10-year and 30-year Indian government bond fell by 3 bps and 1 bp respectively between February 14 and 15. While the front end of the India's yield curve—for short term government debt—is fairly weak, the bond market is growing comfortable with longer duration bonds at this point, Gore said. 

Such behaviour in yields is "typical of this juncture in the rate hike cycle", Gore said, referring to expectations that the central bank is nearing the end of hikes in its benchmark rates. 

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