India bond investors favour short-end after central banks policy surprise

By Dharamraj Dhutia

MUMBAI, June 9 (Reuters) - Indian investors are opting for shorter-duration government bonds and swaps after the central bank cut rates by a surprise 50 basis points and lowered the cash reserve ratio (CRR) for lenders last Friday.

The policy support will steepen the yield curve, with short-term rates falling and longer-term rates stabilising or rising, four investors told Reuters on Monday.

"We continue to see front-end of the yield curve to be well supported," said A. Prasanna, head of research at ICICI Securities Primary Dealership.

Prasanna, however, sees limited scope for a rally in longer-duration bonds as the CRR cut would limit the need for more debt purchases by the Reserve Bank of India (RBI), a tool that would have otherwise lowered long-term yields.

Expectations of a steeper curve are being reflected in markets as yields on up to three-year bonds have declined 4-5 bps since Friday, while the 10-year benchmark yield has risen nearly 18 bps from the low hit on that day.

The outsized rate cut and surplus liquidity are also pushing shorter-tenor swap rates lower.

The one-year OIS swap rate was around 5.45%, while the five-year rate rose to 5.70%, more-than-doubling the spread between the two.

"With more liquidity and lower overnight rate fixings, there is still some room for receiving in one-year swap, but long-end should see some paying," said VRC Reddy, treasury head at Karur Vysya Bank.

Reflecting the shift in sentiment, most investors now expect the 10-year bond yield to stabilise or rise.

Citibank, which held a long position on the 10-year bond, said its conviction level on this trade has reduced due to limited scope for more rate cuts.

Dhawal Dalal, president & CIO - fixed income - at Edelweiss MF, has turned "neutral" from "accommodative" on bonds and expects the 10-year yield in the 6.15%-6.25% band. ($1 = 85.6210 Indian rupees)

(Reporting by Dharamraj Dhutia; Editing by Sonia Cheema)