RBI's policy resets bond markets, signals deeper yield compression ahead

Business Standard

2 days ago

RBI MPC Meeting, bond yields: The Reserve Bank of India's (RBI's) June 6 policy marks a decisive inflection point for India's bond markets. A 50-basis point cut in the repo rate to 5.5 per cent, paired with a 100-bps cut in cash reserve ratio (CRR) staggered over four tranches, delivers a synchronised signal on rate direction and system liquidity. But beneath the surface of these headline numbers lies a deeper recalibration in real rates, yield curve dynamics, transmission velocity, and term premium expectations—all of which decisively shift the center of gravity for debt markets in the months ahead.
The near-term repricing of the yield curve is already visible. The benchmark 10-year G-sec yield, which closed May at 6.29 per cent, dropped 7 bps month-on-month and is now expected to trade in a 6.15–6.25 per cent band in June, as per OIS-implied rates and auction behaviour. This downward bias stems from two structural tailwinds. First, headline consumer price index (CPI)-based inflation moderated sharply to 3.2 per cent in April—its lowest in six years—driven by a 42-month low in food inflation at 2.1 per cent and benign core inflation.
The RBI has revised financial year 2025-26 (FY26) CPI down to 3.7 per cent (Q1 at 2.9 per cent), bringing the real policy rate to just 1.8 per cent, down from over 2.8 per cent in January. Second, the CRR cut—amounting to ₹2.5 trillion in durable liquidity—lowers banks' marginal funding cost and compresses term spreads, particularly in the 1–5Y segment. ALSO READ |
The 5-year segment has already priced in this easing aggressively. The 6.75 per cent 2029 bond yield has declined by 80 bps since March. The spread between 5-year and 10-year yields has widened to a three-year high of 35 bps, with the benchmark 10-Year yield still hovering near 6.18–6.25 per cent—down 39 bps since March but still offering convexity and duration value amid a softening macro. Given the RBI's neutral stance, the 10-Year segment is poised for further compression towards 6.00 per cent over the next quarter, especially as new supply remains orderly and forex reserves remain robust at $691.5 billion, insulating against external shocks.
The 3M–30Y spread has widened to 128 bps as of end-May from 88 bps in April. This steepness is not a distortion—it's a reflection of lagged transmission at the long end while the short end already prices in deeper easing. The average cut-off on 91-day T-bills dropped 14 bps M-o-M to 5.76 per cent, while 364-day paper fell 42 bps to 5.63 per cent. The weighted average call rate (WACR) slipped to 5.83 per cent in May versus 5.95 per cent in April, reinforcing that short-term money markets are front-running rate action. The RBI's own liquidity injections have been sizable: over ₹9.5 trillion since January through OMOs, VRRs, and FX swaps. This abundance has also softened CP/CD spreads, with 3-month CP yields falling 143 bps and CD yields 138 bps during Feb–May, reflecting easing corporate borrowing conditions.
Yet, debt investors must navigate this shift with nuance. RBI's pivot to a "neutral" stance—after three straight cuts totaling 100 bps—signals that the central bank is preserving optionality. Money markets will remain anchored by surplus liquidity. System liquidity is already in surplus (~₹1.7 trillion in May or 0.7 per cent of NDTL), and the phased CRR cut will structurally reinforce this, alongside falling deposit rates. While a final 25 bps cut is a possibility by October (if inflation stays sub-4 per cent), the curve has likely front-loaded most of the easing. The CRR cut, in contrast, will have a staggered impact, pushing duration demand outward as liquidity pressures ease gradually. ALSO READ | PSU and insurance-led demand in G-sec auctions, especially for 5Y–10Y tenors, is expected to remain firm, while SDLs could benefit from lower risk premia as spreads compress. With the US 10Y yield under pressure from growth fears and trade war risk, foreign demand for INR assets may rebound once the rate differential stabilizes. In sum, Short-end repricing is largely done. The medium and long end offer incremental value, especially as term spreads normalize in a low inflation, data-dependent, globally uncertain environment. The RBI has delivered a liquidity bazooka, but the real gains ahead depend on how fast the credit flywheel turns.