Bonds show marginal impact of Fed hike

Mumbai: The US Federal Reserve's overnight decision to raise rates had an outsized impact on Indian stocks, but bond yields moved only marginally as traders weighed the likelihood of further rate action locally after headline inflation in Asia's third-biggest economy finally retreated below the 6% outer bound, having persistently overtopped the tolerance threshold this year.

Yields on the benchmark 10-year bond closed at 7.26%, compared with close of 7.22% Wednesday. India's FY24 borrowing target and future rate action weighed on the sentiment.

Overnight, the Federal Open Market Committee (FOMC) raised its policy Fed Funds rate by 50 basis points to 4.25-4.50% as expected, taking the total quantum of increases in 2022 to 425 basis points, the biggest increase in a single year since the Fed Funds rate became the formal policy target in 1993. One basis point is 0.01%

"FOMC members' median forecast for the Fed Funds rate at end-CY23 rose to 5.1% (from 4.6% previously), while their projection for real GDP growth in CY22 was raised to 0.5% (from 0.2% three months ago) and cut to 0.5% for CY23 (from 1.2% previously). We retain our forecast for the Fed Funds rate to peak at 5% in Mar'23," ICICI Securities said in a note.

The latest fall in India's consumer prices has raised expectations that the central bank could consider pausing rates after raising the benchmark repo rate by a total of 225 basis points this fiscal. India's retail inflation eased to an 11-month low of 5.88% in November from 6.77% in October, reflecting lower food prices. The print is now within the Reserve Bank of India's (RBI) tolerance band of 2-6% for the first time in 2022.

However, bond market participants say more clarity is needed on the rate direction.

"The broad expectations are that the RBI will hike rates one more time. The overnight US hike was on expected lines. Although inflation in both India and the US is on the wane, the market is still cautious and is awaiting more clarity on the inflation trajectory. The 10-year bond is likely to trade in the 7.20% to 7.35% range," said Siddharth Shah, head trading at STCI.

Traders want to see inflation moving below the 6% on a more durable basis before calling for a pause and hence increase in demand for bonds.

"Softer inflation is cementing expectations for a pause. However, sticky core inflation is a cause for concern and may keep repo rate higher in CY23," said Dhawal Dalal, CIO, fixed income, Edelweiss Mutual Fund.