RBI policy verdict, guidance to drive nervous bond market traders

Indian government bonds are expected to open at little changed levels on Wednesday, as the market anticipates the Reserve Bank of India's (RBI) monetary policy announcement. An interest rate increase is already factored in, and there is speculation of more liquidity withdrawal. The benchmark 6.94% 2036 bond yield could trade between 7.18% and 7.20% until the decision, which is scheduled for 10 a.m. IST.

Bond yields increase when prices fall. Sentiment among investors is cautious, as they prepare for a potentially hawkish decision from the RBI. According to a Reuters poll, around 60% of economists anticipate a 25 basis points rate hike from the central bank. Traders also consider the possibility of additional debt sales or a minor hike in banks' cash reserve ratio (CRR).

There are indications that the swap market is suggesting a potential 50-basis points rate increase. HSBC, which advocates for a 25-basis points hike, estimates that the central bank may need to remove approximately 6 trillion rupees ($62.25 billion) of liquidity from the banking system over the coming months. "The increase in currency in circulation could cover 2 trillion rupees, and additional use of existing tools (open market operations, forex spot sales, FX swaps, VRSRs) may help with the remainder," HSBC stated in a note.

In September, the RBI sold bonds worth 1 trillion rupees ($10.39 billion), the largest sale in over a decade, and has been conducting variable rate reverse repos on a daily basis.