Deutsche Bank expects 50 bps repo rate hike in 2022; reverse repo increase in December

Goel is of the view that globally, markets are reacting to the possibility that central banks will have to catch up to what has been more of a supply-side shock.

“There has been a shift in central bank narratives everywhere. Earlier, central banks were of the opinion that this inflation is transitory in nature and that it's not going to be more permanent. But now, because of the negative supply shock, it has compounded the issue. It’s no longer just about bottlenecks in supply chains, but also about energy prices. Inflation looks like a bit more persistent than transitory than what was being expected earlier,” he said.

“However, there is also a worry that this negative supply shock may eventually become a bigger, negative demand shock, which is where the longer-term growth outlook comes into the picture,” mentioned Goel.

According to him, this pandemic has made more structural changes to the global economy than what was previously expected, and so it's unclear as to where the net total of that supply and demand function is likely to land. This is what is being reflected in markets right now- where the front-end of curves are largely pricing in a lift-off, and we have a fair degree of clarity from the Fed on the taper timeline.

However, he does not think it is necessarily very stagflationary, because the backends are not moving since the central banks are interjecting in markets in two different places. “One at the front-end with liquidity and with a sort of price point of policy, but also in most countries at the backend, either via intervention through either sort of absolute Yield Curve Control (YCC), or just quantitative easing of one form or the other. So, there are multiple points of that interjection on the curve, which I think is what is getting reflected. Our house view is that the markets will eventually build in more term premium into the backend of the curve. This means longer-term yields will also rise,” he said.

On key takeaways for the bond market, he said, “It is an easy job for any central bank to exit from the humongous amount of liquidity situation, which it has created, and we have seen that problem with different characteristics of tapering, but we are seeing that problem everywhere. In India, the starting point is Rs 12 trillion odd of excess liquidity and the central bank quite realises that if it has to prepare the economy for tightening of rates and normalisation of policy, the starting point for that is a normalisation of liquidity.”

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“Now, there is a large surplus to move with, but the central bank has no choice but to move on both the quantum and the price of liquidity. What is the sequencing and how it leans on both those factors is obviously a point. The very obvious next step to think about, which they have already signalled by taking away more liquidity at a slightly higher price point, but they are yet to go into longer-term VRRRs, which would signal that it's a bit more permanent or durable,” he said.

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“So, ultimately the next step would be for longer-term of reverse repo to come through and eventually for the reverse repo rate to be lifted for the corridor to be normalised back to about 25 basis points, and then at an adequate interval to then lead to the entire corridor being shifted higher, including the repo,” stated Goel.

“Our view is, the first part of the reverse repo hike is most likely in December, the second part is probably going to be in Q1 of next year, and then following that, Q2 is when the entire corridor starts to move higher. We are looking at 50 basis points of cumulative hikes on the repo rate in 2022, followed by another 50 to 75 basis points in 2023,” said Goel.