India's CPI and Yesterday's Bond Selloff

India’s bonds dropped to a four-month low yesterday, even as July CPI rose 1.55% in what was its slowest pace of growth in eight years. The 10-year bond yield jumped 5 basis points to close out the session near 6.50%, which means that since the lows seen in early June, yields have now risen by nearly 37 basis points. So, it is only fair to ask, what gives?

The simple explanation is that yesterday's bond sell-off was triggered on fresh concerns that the government may increase its borrowing to fund a potential stimulus that may be needed if the 50% tariffs levied by the Trump administration begin to bite. That, and the fact that the RBI projected a sharp pickup in inflation in the first quarter of the next fiscal year, sent a clear message to trading desks that rate cut expectations had to be pulled back.

The evidence of increasing bond supply (more borrowing) was pretty much on point yesterday, seen in a sale of state debt, where higher-than-expected cutoff yields clearly showed weak demand. This means investors, such as mutual funds, insurers, etc., were expecting a higher coupon on these state bonds, but since the coupons at which they were issued were low, the bonds did not get many takers.

Meanwhile, there is plenty of uncertainty about how the government will tackle the tariff challenge. Exporters are already asking for relief measures, and if the government increases its subsidy to support certain industries, the bill for such intervention will have to be footed by borrowing more than was originally expected. This is starting to play out, affecting sentiment in the bond market.

Coming to the 10-year yield, the 6.55 - 6.60 area is what market participants are watching. What happens here will decide whether the bond selloff is temporary in nature or something more.

Meanwhile, here is some trivia:

● What is the "cut-off yield" often used in the bond markets?

When a government or a company wants to borrow money, it issues bonds. Now, when people want to buy these bonds, they submit bids, saying how much they're willing to pay and what yield (return) they're looking for. The issuer (the government or company) looks at all the bids and decides, "Okay, we'll accept all the bids that offer a yield at or below a certain point." That certain point is the cutoff yield.

So, if the cutoff yield is, say, 5%, it means they'll accept all bids where the investor is willing to accept an interest rate of 5% or less. Anyone asking for a higher interest rate (a higher yield) won't get their bid accepted.

It's essentially the maximum interest rate the issuer is willing to pay to borrow money. It helps them get the money they need at the lowest possible cost.