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Bond yields continued to harden as brent crude surged above USD 117/bbl, with RBI taking more administrative steps to stall  INR depreciation. The month started with the MPC policy on 7th October where the policy rates were hiked as per expectations with change in the monetary policy stance to “Calibrated tightening” from “Neutral”, which was not fully factored in by the markets. The decision to hike the policy repo rate was unanimous while the decision to change the monetary policy stance was taken with a 4-2 majority; Dr. Kumar and Prof. Singh dissenting in favour of retaining the “Neutral” stance.

The monetary policy stance is not put to vote but is the opinion of the MPC members. Beyond the MPC policy, INR continued to depreciate, towards 97/USD. RBI intervened forcefully in the FX markets, announcing a series of strong administrative steps to arrest INR weakness. The fact that RBI needed these steps to stem INR fall little over a month after the close of the FCNR scheme where inflows exceeded all estimates, highlights the pressure on INR amidst strong USD demand. RBI intervened heavily in the FX market also, draining liquidity from the banking system with the MSF rate becoming the operational rate. Sentiments were further roiled as the RBI Governor, in a media interaction, commented that, if needed, interest rates can be used as a tool for ensuring financial stability. All these led to a selloff in bond yields across the yields curve, which bear flattened. Money market yields rose sharply with 3 month maturity yields rising more than 100 bps to 7.60%. Forward premia in the FX markets spiked sharply with 1yr implied forward premia yielding above 4%, well above the levels indicated by interest rate parity.

CPI inflation for September came in line with expectations at 5.54% , which is a two year high. “Core” inflation rose to 4.30% (4.20% in August). Importantly, the sequential price pressures continue to point to stronger gains. Inflation in 46% of items in the CPI basket is now tracking above RBI’s inflation target of 4%, compared with 37% of items in that bucket in August and 20% of items in that category at the end of last fiscal year. CPI inflation is likely to inch towards 6% and stay elevated close to that level for next couple of quarters. WPI inflation rose to a 4-yr-high of 11.39%, much higher than market expectations of 10.60%. “Core WPI“ also rose to 9.80% compared to 8.10% in August.

Overall, WPI was led by higher food and fuel prices. WPI is likely to stay elevated around 11.50% over the next couple of months. MPC minutes showed some concern on second round effects of supply side inflation and the rate hike in October showed the MPC intent on acting preemptively to counter the possible second round effects. Even as the two external members (Prof. Singh and Dr. Nagesh Kumar voted to retain a “neutral” monetary policy stance, Prof. Singh mentioned that room for incremental rate hikes remains. Overall, the minutes highlight the MPC’s intent to maintain and preserve price stability.

FPI flows were negative. OIS yield also rose in line with sovereign yields with the 1-yr OIS yield rising by 52bps and the 5-yr OIS yield rising by 21bps. INR stabilised post RBI’s administrative steps and heavy intervention the FX markets both in spot and swaps. INR ended the month at 94.95/USD, appreciating by almost 1% during the month even as FPI outflows continued both in debt and equity to the extent of USD 350mn and USD 2.20bn, respectively. Brent crude ended the month at USD 117.64/bbl up more than 13% in the month.

Globally, bond yields retracted from their highs with the benchmark US 10yr bond yield falling below 5%, ending the month at 4.93%, down 35bps from the start of the month. The US Fed kept status quo on policy rates as expected though markets are discounting future rate hikes. Yields also fell in Europe and Japan. We continue to expect further rate hikes from MPC and expect incremental 100bps rate hikes over the next 6-9 month.  

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