As RBI pulls support, bond market may be on the brink of prolonged rout

The decision by the Reserve Bank of India spurred speculation that it has run out of ammunition after slashing rates five times this year.

It’s starting to look like India’s sovereign bond market is on the brink of a prolonged rout. Traders have shied away from the long-end of the curve since July on concern the government will expand record bond sales. Sentiment toward the short-end, which closely tracks policy rates, turned negative Thursday after the central bank surprised by holding off on easing.

The decision by the Reserve Bank of India spurred speculation that it has run out of ammunition after slashing rates five times this year. Hopes that the central bank would announce plans to buy bonds were also dashed. Yields on the 2-year bonds jumped by the most in almost three years on a closing basis.

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“The market has no confidence that the RBI will buy bonds, and on top of that you have the pause, which puts a question mark on rate cuts,” said Rajeev Radhakrishnan, who oversees $6 billion in debt funds at SBI Funds Management Pvt. “It is an additional negative for the market.”

The two-year bond yield jumped 23 basis points at the close on Thursday, the most since December 2016. The benchmark 10-year closed 15 basis points higher.

The central bank said it resisted pressure to ease further following a recent increase in headline inflation. Governor Shaktikanta Das said the authority also decided to wait and see how the cuts already delivered pan out.

With inflation expected to edge higher this month and the next, the worry for bond traders now is that the RBI may keep rates on hold at its February policy meeting too.

“The key message from the RBI is that there’s limited policy space and it is looking for maximum bang for every rate-cut buck,” Nomura Holdings Inc. analysts led by Singapore-based Sonal Varma, wrote in a note. “The relative underperformance from bonds and wide spreads suggests that market sentiment is already extremely negative.”