Monetary Policy : Was RBI too quick to abandon the accommodative stance in its Feb policy?
Back in Jan, when banks were awash with liquidity, thrown in generously by demonetization impact, debate was not about whether there will be a rate cut or not , but how aggressive it will be. Bond Markets were magnanimously marking up the gilts to new highs, as they started factoring in a sizable slice in the rates by RBI (rates and bond prices are inversely related). Some opportune analysts jumped in the fray to make outrageous forecasts on the 10 year yield (on the downside) to feed on to the media frenzy and thereby getting opportunity to hit headlines. Consensus trade was conspicuously long on bonds. Needless to say, traders were sitting on a sizable MTM (mark-to-market) gains in their bond portfolio. So far so good, so it appeared.
But all hell broke loose on 8th Feb when RBI, in an unusual move, decided to change its monetary stance from accommodative to neutral citing following fears.
- Hardening profile of international crude prices.
- Volatility in exchange rates on global cues which could impart upside pressures to domestic inflation.
- Aggressive rate hikes by Fed on positive US outlook as reflected in the rising US yield
- Impact of 7th pay commission on inflation
For the bond markets, that shift was surreal and bizarre, as they were counting on surging liquidity in the banking system for raving rate cuts. Shift in stance was significant as it ruled out rate cuts for the foreseeable period. That was a blow to the markets that were marking-in large cuts in the bond prices. What followed was mayhem in the bond markets, triggering a huge sell-off. Prices slumped and yield surged by over 50bps in few quick sessions.
Three months have passed since RBI took that significant shift in stance. We now have the real data to assess whether RBI/MPC (Monetary Policy Committee) went overboard on its fears. Here is the chart that captures the movement of those indices (since Feb) that RBI/MPC was tracking closely for its assessment. As can be inferred from the chart, none of them played out the way RBI had feared. In fact, all of them have moved in the opposite direction, much more favourably for a dovish stance than a hawkish one.
Though it is too early to draw any major conclusion, on the evidence of data over past three months, it certainly seems that RBI could have waited for more data before deciding on the shift in stance. With softening crude and soaring Rupee, fears of spike in inflationary pressures have been proved totally unfounded. With additional support coming from slumping US ten year yield on rising risks for Trump’s reflationary trade ( with increasing fears on Trump’s ability to pump-up bipartisan support for fiscal stimulus or tax cuts), RBI/MPC might find it difficult to sustain its hawkish stance, unless these trends reverse.
For long-term debt investors, the current subdued price in the bond markets is a stellar opportunity given the potential upside in returns when the policy stance swings back to accommodative. At the moment, data-points (ref chart above) are favourably inclined for such a shift, though timing of which is difficult to predict.
Happy Value Investing!!