RBI Rate Cut Triggers Bond Market Frenzy: Yields Dip Then Recover Amidst Profit Booking!

RBI Cuts Repo Rate, Bond Yields React

The Reserve Bank of India's Monetary Policy Committee has announced a 25 basis point cut in the policy repo rate, bringing it down to 5.5 per cent. This move led to an immediate fall in the yields of government bonds.

Bond Market Volatility

• The yield on the benchmark 10-year government bond touched a low of 6.45 per cent during Friday's trading session following the rate cut announcement.
• However, the gains were partially reversed by the end of the day, with the yield settling at 6.49 per cent, slightly down from its previous close of 6.51 per cent.
• This reversal was driven by profit booking from mutual funds and private banks who sold bonds after the initial fall in yields.

RBI's Open Market Operations (OMO) Announcement

• The central bank also announced Open Market Operations (OMOs) involving the purchase of Rs 1 trillion worth of bonds this month, which initially helped push yields lower.
• RBI Governor clarified that OMOs are primarily intended to manage liquidity in the system, not to directly control government security (G-sec) yields.
• He reiterated that the policy repo rate is the main tool for monetary policy, and changes in short-term rates are expected to transmit to longer-term rates.

Market Sentiment and Profit Booking

• A segment of market participants believes that the recent 25 basis point rate cut might be the final one in the current cycle.
• This view prompted some investors, particularly mutual funds and private banks, to book profits in the government bond market.
• Dealers noted that profit booking also occurred in overnight indexed swap rates.

Governor's Views on Yields and Transmission

• The RBI Governor addressed concerns regarding bond yield spreads, stating that current yields and spreads are comparable to earlier periods and are not elevated.
• He explained that it is unrealistic to expect the same spread on a 10-year bond when the policy repo rate is lower (e.g., 5.50-5.25 per cent) compared to when it was higher (e.g., 6.50 per cent).

Auction Results and Future Outlook

• The government successfully auctioned Rs 32,000 crore worth of 10-year bonds, with the cut-off yield at 6.49 per cent, aligning with market expectations.
• Axis Bank anticipates the 10-year G-Sec yields to trade within the 6.4-6.6 per cent range for the remainder of FY26.
• Factors like lower inflation, strong economic growth, upcoming OMOs, and potential inclusion in Bloomberg indices could offer tactical opportunities for long bond investments.

Impact

• This news has a moderate impact on the Indian bond market and indirectly on borrowing costs for companies and the government. It signals the central bank's stance on interest rates and liquidity. Impact Rating: 7/10

Difficult Terms Explained

• Repo Rate: The rate at which the Reserve Bank of India lends money to commercial banks, usually for short periods. A cut generally lowers borrowing costs.
• Benchmark 10-year Government Bond Yield: The annual return an investor expects from lending to the government for 10 years, considered a key indicator of interest rates in the economy. Yield moves inversely to price.
• Basis Points (bps): A unit of measure used in finance to describe small changes in interest rates or other percentages. One basis point is equal to 0.01%.
• Open Market Operations (OMOs): The buying or selling of government securities by the central bank to manage liquidity and influence interest rates in the money market.
• Liquidity: The ease with which an asset can be converted into cash. In finance, it refers to the availability of cash or easily convertible assets in the banking system.
• Profit Booking: Selling an asset (like bonds) that has increased in value to realize the gains and reduce risk.
• Overnight Indexed Swap (OIS): A derivative contract where one party exchanges fixed interest payments for floating interest payments for a specified period, typically overnight rates.
• Monetary Policy Committee (MPC): A committee of the Reserve Bank of India responsible for setting the policy interest rate (repo rate).
• Dovish: Refers to a monetary policy stance that favors lower interest rates and is generally accommodative, aiming to stimulate economic growth.
• G-sec: Government Securities, which are debt instruments issued by the central or state governments to borrow money.