Domestic Bonds

Bonds: Cutoff Higher Than Expected During RBI Reverse Repo, US Developments Bring Hawks Back to Money Markets

NEW DELHI; Indian financial markets have been tricked a bit over the past two days as a flurry of developments from central banks, both global and domestic, created speculation among investors about how quickly the international liquidity flow triggered during the Covid crisis will be paid off.

Benchmarks fell more than 1% on Tuesday, the rupee closed at a one-month low, while the yield on the 10-year benchmark government bond climbed 2 basis points. The prices and yields of bonds move in the opposite direction.


Domestically, the most recent trigger was what appeared to be a harmless cutoff rate set by the Reserve Bank of India in a floating rate reverse repo auction.

Even though the goal of these operations – undertaken by the RBI since January 2021 – was ostensibly to align the cost of funds with benchmark rates, the closing rate set by the central bank on Tuesday was the first in recent times. to be close to the reverse repo rate of 4.00 percent, not the actual effective rate, which is the reverse repo rate of 3.35 percent.

On Tuesday, RBI set a threshold of 3.99% in a seven-day floating rate reverse repurchase auction, the highest possible threshold for such a transaction and just below the reverse repo rate in force.

For investors in both bond and equity markets, the RBI’s decision has set the cat among the pigeons when it comes to guessing when the central bank will choose to undertake an appropriate realignment of rates. interest towards the benchmark key rate – something that hasn’t been done for the past two years.

Over the past two years, it is the reverse repo rate that has served as the operational funding benchmark for markets as the central bank released a burst of liquidity to keep funding costs low in dire need. to revive economic growth, but before and during the coronavirus crisis.

If the RBI is indeed sending a message that it wants to bring the cost of funds down to the benchmark policy rate, one of the main ways of doing this would be to begin to significantly curb the massive excess liquidity in the industry. banking. system.

In the past six months at least, core cash – the sum of the government’s cash balance and banking system cash – has been around Rs 10 lakh crore.

The RBI has already taken the step of draining a greater amount of liquidity by increasing the amount of theoi of variable rate reverse repurchase transactions and there is speculation that in the coming months the duration of these transactions will know. also an increase.

In addition, earlier this month in its “Government Securities Acquisition Program”, RBI also announced for the first time as part of these transactions a sale of government securities as well as purchases, albeit those of duration. shorter.

All of these signals point to the central bank’s intention to now step on the pedal with regard to the normalization of liquidity management operations.

Speculation is now rife that in the next September 8 monetary policy statement, the RBI may be able to detail a timeline for a repo rate hike, possibly for December.

To be fair, when it comes to acting on the repo rate, the RBI may take a step outside the intended policy statement, as the mandate of the Monetary Policy Committee is to act on the. repo rate and not on the lower bound of the liquidity adjustment facility corridor. .


For stocks, which have been hovering near life highs for a few months now, a tightening of the liquidity tap, both global and domestic, could result in a reversal of some of the extraordinary flows that have been propelled into the Indian market.

As long as the cost of funds, internationally, has remained close to record lows, the market has been confident that even if growth prospects remain fragile, flows are assured.

Now that U.S. Treasury yields have climbed nearly 20 basis points over the past month as the Federal Reserve hints at a reduction in quantitative easing in November and a likely tightening in monetary policy shortly After a while, emerging market assets such as India lose their luster. as evidenced by the reaction of domestic markets.

“In equities the reaction was a bit more sudden as the market initially ignored the Fed’s statement, but now with confusion over the US debt ceiling and a possible default threatening to push US yields even higher , the problem strikes at home. “said a sales manager at a foreign bank on condition of anonymity.

Republican senators in the United States have opposed Democrats’ efforts to raise the country’s debt ceiling, sparking fears that the world’s largest economy could default on its bonds.

“This is a double whammy as signs of improving growth prospects and monetary tightening in the world’s largest economy have also pushed up crude oil prices and the rupee is now starting to suffer as well, the RBI will have to act on liquidity to some extent if the Fed starts to tighten, ”he said.


Some believe that the recent reaction of the markets may have been instinctive and that as far as the RBI is concerned, the process of raising interest rates is still a long way off.

According to many Treasury officials, the high threshold set in the floating rate reverse repo auction was more the result of some banks refraining from parking at the window until the end of the July-September quarter. .

The fact that the Reverse Repo auction was not fully subscribed on Tuesday confirms this point of view. Typically, public banks, which are the largest deposit holders in the system, prefer to hold cash towards the end of the quarter in order to prepare for possible cash outflows.

“We could see a threshold of 3.60% again in the next reverse repo auction, I think the threshold of 3.99% was unique.”

Another factor that has comforted some in the market is a recent wave of interactions between RBI officials in which they have pointed out that the central bank will give a very clear warning to the markets before embarking on the normalization process.

It is clear from the previous RBI monetary policy statement in August that in the future the direction of interest rates is north, but the disappointing growth figures for April-June appear to have pushed this possibility further back. far.