Commercial banks are set to make trading gains as the yield on the benchmark 10-year government bond fell 19 basis points in April-June to settle at 7.12 per cent on the last trading day of the first quarter.
Banks face a staggering notional loss of Rs. 71,817 crore for 2022-23 should they mark to market all bond portfolios, including their held-to-maturity (HTM) holdings, according to the Financial Stability Report by the Reserve Bank of India (RBI).
The amount is one-third of the profits reported by banks in 2022-23.
Bond yields went up sharply last financial year on the back of a 250 basis point hike in the policy repo rate by the RBI.
However, the first quarter this financial year was one of optimism for the government bond market.
“There should be some reversal for banks,” a dealer at a state-owned bank said.
Bond yields inched up by 6 basis points on Friday due to a rise in US Treasury yields, and lower than the expected cut-off at Rs. 33,000 crore.
“The cut-off on 10-year paper (benchmark 7.26 per cent 2033 bond) was not even at the market level. I see the yield (on 10-year paper) inching up to 7.14-7.15 per cent,” a dealer at another state-owned bank said.
“This is because positive sentiment has started wearing off; there is nothing positive in the market right now.” Meanwhile, the yield on the benchmark 10-year US Treasury note rose 13 basis points to a three-month high of 3.85 per cent on Thursday as the recent data indicated the US economy strengthening, thereby, making strong the expectations of a rate hike by the US Federal Reserve.
The yields on domestic government bonds fell in April-June due to positive market sentiment after the Monetary Policy Committee decided to keep the repo rate unchanged at 6.50 per cent, in its meeting on April 6. The domestic rate-setting panel paused the rate hike cycle after six consecutive increases aggregating 250 basis points since May 2022, thereby prompting traders to stock up on government bonds, betting that the committee’s next action would be a rate cut. On May 13, the yield on the benchmark 10-year bond settled below 7 per cent for the first time since April 2022.
Moreover, the headline consumer inflation rate moderated to 5.66 per cent in March, falling within the target band of the RBI and the lowest since December 2021.
The RBI’s inflation target is 4 per cent, with a tolerance band of two percentage points, both above and below the target. After briefly reaching the target range in March, India’s consumer inflation has been declining, and it reached a 25-month low of 4.25 per cent in May.
However, dealers say market participants went overboard, expecting rate cuts as early as October.
“The markets went overboard as the data was not there, and the RBI’s expectations about tackling inflation were different from what the markets were looking at,” Naveen Singh, head of trading and executive vice-president at ICICI securities primary dealership, said.
“The RBI is not okay with inflation just being within the tolerance band; rather it wanted it to be close to 4 per cent or below 4 per cent.”
Market sentiment took a turn after RBI Governor Shaktikanta Das said in his post-policy speech in June that the rate-setting panel was aiming to achieve the 4 per cent inflation target, and would continue the withdrawal of accommodation stance.
Additionally, the US Federal Open Market Committee signalled more rate hikes in the current calendar year, even though the US rate-setting panel kept the interest rates unchanged at 5-5.25 per cent, in its June meeting.
As a result, the rate cuts expectations got pushed to February or the first quarter of the next financial year.
“There was a broad expectation that by the end of the current calendar year, there will be a rate cut by the RBI,” said Vijay Sharma, senior executive vice president at PNB Gilts primary dealership.
“Now the market is expecting a rate in the first quarter of the next calendar year.”