MUMBAI - India's shorter-tenor government bond yields are expected to fall further on bets of a turn in U.S. monetary policy later in the year and as foreign banks accelerate their bond purchases in the new year, analysts said.
"The market is eyeing a Federal Reserve policy pivot soon and hence there is a rally in U.S. Treasuries," said Kunal Kundu, India economist at Societe Generale.
"This is also resulting in foreign banks buying Indian bonds. They are targeting the 2026-2028 segments."
Foreign banks have bought government bonds worth 208 billion rupees ($2.56 billion) on a net basis so far in January, nearly matching their aggregate net purchase in the August-December period.
"Our view on the five-year is constructive, and we expect five-year bond yields dropping to 6.75% by the end of this year," said Ashish Agrawal, head of FX and EM macro strategy research, Asia, Barclays.
"There will be a bullish move at the front end, even as the longer tenors see range-bound moves."
The five-year 7.38% 2027 bond yield was at 7.16%, down by 12 basis points (bps) in the last two weeks, even as the benchmark 7.26% 2032 bond yield was nearly flat in the same period.
The spread between the five-year and 10-year bond yield has doubled to 20 bps in January and is expected to widen further.
"In the front end, we are looking at lower impact from the supply, and if the hiking cycle is over, the shorter-tenor bonds will start converging with the policy rate," Barclays' Agrawal added.
Weaker economic data and easing inflation in the U.S. have led to a sharp drop in U.S. yields and cemented expectations of rate cuts in the world's largest economy in the last quarter of 2023.
The 10-year U.S. yield dropped over 50 bps to 3.32% in the first three weeks of the New Year as the market grew confident about a policy pivot.
The Fed raised interest rates by 425 bps in 2022 to fight inflation and is broadly expected to raise them by another 50 bps in early 2023, before reverting to rate cuts.
Meanwhile, expectations of an elevated borrowing for the next financial year may weigh more on the longer-duration papers, which see the bulk of the supply.
"We are maintaining the bulk of our positions in up to five-year bonds, which will relatively see less supply and we could see steepening of the yield curve," said Vijay Sharma, senior executive vice president at PNB Gilts. ($1 = 81.1625 Indian rupees)
(Reporting by Dharamraj Dhutia; Editing by Janane Venkatraman)