RBI warns bond markets to avoid ‘tandav’ of high interest rates

RBI warns bond markets to avoid ‘tandav’ of high interest rates

“It is recovering but certainly not out of the woods yet,” the report said.“It is recovering but certainly not out of the woods yet,” the report said.

The Reserve Bank of India (RBI) has warned the bond markets against pushing yields higher at a time when the central bank is aiming for an orderly evolution of the yield curve. There is “no way” the economy can withstand higher interest rates at this stage, the RBI said in its bulletin for March.

“As countries rush to inoculate their populations, the global economy should regain lost momentum in Q2. Bond vigilantes could, however, undermine the recovery, unsettle financial markets and trigger capital outflows from emerging markets. The Reserve Bank is striving to ensure an orderly evolution of the yield curve, but it takes two to tango and forestall a tandav,” the ‘State of the Economy’ report in the bulletin said.

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Investors must understand their exposures when they set about to scour the landscape and exploit signs of market dysfunction. According to the central bank, what markets do not realise beyond the break evens, TIPS and policy stimulus is that there is no way the economy can withstand higher interest rates in its current state. “It is recovering but certainly not out of the woods yet,” the report said.

The benchmark 10-year yield, which had averaged 5.93% during April, 2020 to January, 2021 surged to 6.13% on February 2 on the announcement of the market borrowing programme of the central government, which turned out to be higher than what was expected. Following the announcement of measures by the RBI on February 5, the benchmark eased to 5.96% by February 11.

The report attributed the hardening of yields thereafter to global spillovers in the form of hardening crude prices, announcements of fiscal stimulus, inflation fright as revealed in break-evens and fears of central bank stance reversals, and a lukewarm response to the US Treasury’s primary auction. “It is a familiar script. The pandemic stirs a heady cocktail – fiscal stimulus; monetary accommodation; release of pent-up demand; vaccine rollout – on which the bond vigilantes thrive,” the report said. As growth forecasts for 2021 are raised, these “vigilantes” see in them the looming possibility of long dormant inflation. With these latent anxieties, they turn sceptical about the central bank’s promise to remain accommodative and start the rout.

“Nevertheless, forewarned is forearmed: bond vigilantes are riding again, ostensibly trying to enforce law and order on lawless governments and central banks but this time around, they could undermine the economic recovery and unsettle buoyant financial markets,” the RBI said.

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