Optimism in Rate Markets to Continue

As two critical hurdles (US Fed and Bank of Japan - BoJ - policy) have now passed, momentum in the domestic rate market will be focussed on The Reserve Bank of India's (RBI) policy, says India Ratings and Research (Ind-Ra). The rupee will stay firm and could trade at 66.45/USD-67/USD (66.65/USD on 23 September) throughout the week, while the old 10-year G-sec yield trading range could be at 6.92%-6.98% (6.97% on 23 September).

BoJ Policy Potential for Carry Trade: The agency believes BoJ policy can actually propel carry-trade in the near future. The BoJ has announced a long-term 10 year financing window at a fixed rate, expanding from the existing facility of a 1-year window. As a consequence of eliminating refinancing and interest rate risks, the new facility could encourage Japanese institutions to run leverage investments in other economies offering higher rates. This has also come at a time when the Yen has strengthened 20% from record lows in recent times, leaving scope for potential weakening. Since India is a preferred destination for Japanese institutions and corporates, high interest rate differential could augment portfolio flows from Japan in the future. Similarly, investments in the US Treasury by Japanese institutions will auger well for the low US yield and be supportive for emerging economies.

Focus on Policy and Auction Calendar: With Monetary Policy Committee (MPC) in place, the market can hope for an action on the rate front after April 2016. In the interest rate market, both the SWAP curve and G-Sec curve have fallen further in recent times, corroborating market expectations of an imminent rate cut. The agency believes scope for RBI's action on rate front appears skewed towards December policy review than October 2016. While the very short-term rates are aligned with policy rates, the underlying G-Sec curve is 40bps above the policy rate, providing further room for softening.

During this week, the RBI is scheduled to release the calendar for government borrowings through dated securities and short-term treasury bills, and an indicative calendar for the auction of State Development loans. The remaining borrowing through dated government securities will be INR2.45trn on a gross basis and INR1.8trn on a net basis, as per the Union budget. On the other hand, INR2trn of state development loans are likely to be issued in 2HFY17.

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