Short-term rates at their highest in almost three years

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Ahead of the Monetary Policy Committee (MPC) meeting next week, short-term yields are soaring. On Wednesday, the yield on one-year Treasury bills hit 6.08% at the Reserve Bank of India (RBI) auction. These are the highest levels since July 2019 and near three-year highs.

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

Meanwhile, as bond markets brace for another 40 basis point hike in the repo rate, the benchmark’s yield climbed to 7.433 on Thursday, up 2 basis points. The recent high was 7.47% on May 9, after the MPC opted to raise the repo by 40 basis points on May 2. Five-year paper also lost value, with the yield rising 2 basis points to 7.23%.

It has been evident since early May that the MPC will choose to anticipate rate hikes rather than pace itself. The first milestone is 5.15%, where the repo was in February 2020, before the pandemic. The consensus is for a 40 basis point hike in June followed by another 35 basis point hike in August. Thereafter, the pace of increases would depend on inflation forecasts; while some economists see a terminal repo of 5.5-5.75%, although some think it could cross 6%.

“Given the government’s large borrowing program, the central bank is unlikely to consider a terminal repo rate above 5.5%,” the big bank’s treasurer said.

RBI Governor Shaktikanta Das confirmed in a recent interview that there will be further rate hikes in upcoming meetings; it was “no hassle,” he said. However, the central bank’s narrative is unlikely to be unduly hawkish, dealers say, as it would sour sentiment.

During the monetary policy review in April, the central bank said it was prioritizing inflation concerns over growth and raised the inflation forecast by 120 basis points to 5.7% . However, this is expected to increase further and the revised guidance for the current fiscal year will be closely watched. A stronger-than-expected rise in forecasts will push yields higher. The markets do not expect OMO (Open market Operations) in the immediate future. The central bank, they argue, would not want to appear overly concerned. Additionally, they point out that the RBI would like to wait a few months to provide an update on geopolitical events and global crude oil prices.

Meanwhile, companies are borrowing heavily from the corporate bond market in an effort to secure lower interest rates. Bloomberg reported that about Rs 8,330 crore was mopped up in the past three days and another Rs 8,590 crore is expected to be lifted before the end of the week.

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