Bond Traders Lament Volatility Surge on RBI Policy Black Box

Updated on
  • “You can’t move a car from third gear to neutral gear”: Iyer
  • Benchmark notes had the biggest loss since 2013 on policy day

India Policy U-Turn Risks Growth Blowback

Three out of three. That’s how many times the Reserve Bank of India’s monetary policy panel has wrong-footed the markets since its October debut. Its latest surprise last Wednesday triggered a five-fold jump in bond volatility, with the benchmark notes posting their biggest loss since 2013.

The move to unexpectedly hold borrowing costs unsettled traders who argue that authorities’ prior commentary had suggested they were comfortable with the inflation outlook and gave market participants the impression that an interest-rate cut was on the cards. The accompanying change in the policy stance to neutral from accommodative hardened the blow for the markets.

“You can’t move a car from third gear to neutral,” said Lakshmi Iyer, Mumbai-based chief investment officer for debt at Kotak Mahindra Asset Management Co. “Maybe the central banker could have been a tad more pro-active in guiding the markets, providing cues and nuances between policies. The carnage in the bond market may not have been so acute.”

India’s 10-year bond yield surged 31 basis points on Wednesday and another 12 basis points on Thursday as investors started unwinding bets for further easing. It was little changed at 6.80 percent on Monday. A gauge of 10-day historical volatility on the notes has since climbed to 26.7 percent, the highest since 2013, from 4.6 percent on Tuesday. Foreign holdings of local government and corporate debt dropped by 8.3 billion rupees ($124 million) on the policy day, halting a six-day increase.

“This sudden shift in gear has left quite a few investors, including foreigners, baffled,” Iyer said.

Authorities held rates even while saying that India was unlikely to overshoot its March 2017 inflation goal of 5 percent. Consumer-price gains probably slowed to 3.24 percent in January, the median estimate in a Bloomberg survey shows before official data due later on Monday. December’s 3.41 percent increase was the smallest since November 2014. Over the medium term, the RBI is targeting 4 percent inflation through 2021, while allowing it to fluctuate in a 2 percent to 6 percent band.

“RBI’s communication with the markets has been an issue,” according to Gopikrishnan MS, Mumbai-based head of foreign exchange, rates and credit for South Asia at Standard Chartered Plc. “It has moved its policy stance from accommodative to neutral after highlighting in the last three meetings that risks to achieving the March inflation target have been going down.”

Alpana Killawala, a spokeswoman for the RBI, didn’t immediately respond to a request for comments.

Taking India’s first collective rate decision in October, the RBI panel lowered the benchmark repurchase rate when the consensus was for no action. It then held fire in December, when a majority of analysts predicted a cut in the aftermath of Prime Minister Narendra Modi’s shock currency recall.

RBI vs Fed

The six-member team has been unanimous in all its rate resolutions, thus failing to offer any indication of individual biases of members. While Governor Patel is known for his media reticence, other panel members too haven’t guided investors on monetary policy since taking charge.

“From the minutes of the previous two MPC meetings it can be inferred that it is a highly structured set-up,” Soumya Kanti Ghosh, group chief economic adviser at State Bank of India, the largest lender, wrote in a Feb. 8 note. “If we take a look at the minutes of the Federal Reserve’s meetings, these are more spontaneous and there is much more detailed discussion regarding the various aspects of the economy before arriving at the conclusion.”

‘Expect The Unexpected’

Investors are also disconcerted as the RBI last week lent a more immediate focus on the 4 percent medium-term inflation goal. The dissonance between the central bank and the market’s reading of when the inflation targets will be met is causing the yawning gap between the expected and actual outcomes of policy meetings, they say.

“The RBI, in its post-meeting statement and press conference, conducted an exercise that can be best described as trying to find reasons not to have eased its stance,” Dariusz Kowalczyk, Hong Kong-based senior emerging-market strategist at Credit Agricole CIB, wrote in a Feb. 8 report. “This causes unnecessary high volatility for rupee assets and leaves observers with an unusual degree of uncertainty regarding the policy outlook. It almost makes sense to expect the unexpected.”

(Adds estimate for January inflation in the sixth paragraph.)
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