Bonds rally to 3-year highs on easing inflation

Last Updated: Tue, May 14, 2013 12:35 hrs

By Rafael Nam and Neha Dasgupta

MUMBAI (Reuters) - Bonds rallied on Tuesday, sending the 10-year bond yield to its lowest in almost three years, after data showing sharply easing wholesale inflation spurred hopes the central bank would cut interest rates further.

Bonds were also supported by hopes the Reserve Bank of India (RBI) would buy bonds. Tight liquidity conditions have led lenders to borrow more than 1 trillion rupees from the central bank repo window for five of the past six sessions.

The 10-year bond yield has now fallen more than 25 basis points since May 3, the day the RBI disappointed investors by signalling a more hawkish stance on monetary policy despite cutting interest rates by a third time so far this year.

Although investors are now betting the RBI may cut rates again, some analysts also cautioned that hefty debt auctions in months ahead and a potentially wider current account deficit may prevent bonds from rallying too much.

As part of those debt auctions India is set to unveil a new 10-year bond on Friday.

"It is a frenzy. The market is pricing in a rate cut," said Ashish Vaidya, head of treasury at UBS in Mumbai.

"But over a two-month period, yields are unlikely to ease significantly, because eventually the supply will catch up," he added.

The benchmark 10-year bond yield fell 11 basis points (bps) to end at 7.47 percent, the lowest since June 2010.

The soon-to-be-unveiled 10-year bond maturing in 2023 closed at 7.32 percent in the when-issued market. Securities trade on a when-issued basis when they have been announced, but not yet issued.

The benchmark 5-year swap rate fell 13 bps to 6.72 percent, after earlier touching the lowest since September 2011. The one-year rate dropped 11 bps to 7.09 percent, the lowest since early January 2011.

Gains were spurred by data showing April wholesale price inflation slowed to 4.89 percent, the lowest since November 2009 and well below the 5.50 percent estimated by analysts in a Reuters poll.

That could spur additional rate cuts, according to analysts, even after the RBI has already eased the repo rate this year by a total of 75 basis points.

Data on Monday showed annual consumer price inflation slowed for the second straight month in April to 9.39 percent.

Investors are also betting the central bank will buy more debt to ease a tight liquidity deficit. The RBI last week bought nearly 100 billion rupees, and investors expect additional purchases this week.

That cash deficit could worsen given that India plans to borrow a total of 3.49 trillion rupees between April and September, including a 150 billion rupee sale this week that will include a new 10-year bond.

Bonds will thus be dependant on how the RBI manages liquidity conditions in the months ahead, risking falls should the central bank not buy as much debt as expected.

A debt rally could also come undone should concerns about the current account deficit intensify. Data on Monday showed that a 138 percent jump in gold and silver imports from a year ago led to a spike in the trade balance last month.

(Additional reporting by Swati Bhat and Shamik Paul; Editing by Kim Coghill and Anupama Dwivedi)

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