Overnight swap rates suggest RBI pause, hint at possible rate hike

India's overnight indexed swaps signal that the central bank's rate-cut cycle has likely run its course, anchoring short-term rates, while longer-tenor ​rates are being pulled higher on expectations of firmer inflation ​and robust growth.

The one-year OIS is currently at 5.50 per cent, 25 basis points above the Reserve ‌Bank of India's repo rate, indicating that markets have priced out further rate cuts and are starting to factor in the possibility of a hike over the next 12 months.

Meanwhile, longer-tenor swaps have firmed. The most actively traded 5-year, which is sensitive to inflation and growth expectations, has risen by 23 bps since January to 6.15 per cent.

OIS rates are the closest gauge of interest rate expectations.

The move comes in the backdrop of RBI raising its immediate GDP growth and inflation forecasts.

Inflation, while currently benign at 1.3 per cent year-on-year in December and seen averaging around 2.1 per cent in the fiscal year through March, is projected to accelerate ‌in the next financial year.

On growth, RBI Governor Sanjay Malhotra has highlighted continued capex support and said that recently inked trade agreements with European Union and U.S. should lift exports and strengthen economic momentum.

The upcoming release of inflation and growth data under a new series this month could prompt a reassessment of the expectations.

Near Consensus Call 

The intersection of a nearly exhausted rate-cut cycle, robust domestic growth, and rising inflation expectations is prompting analysts to recommend "steepener" trades.

These positions capitalize ​on the widening gap between the short and longer portions of the curve. They are further supported ‌by expectations that the RBI will continue to provide liquidity support, which act to anchor short-term swaps.

Analysts at Goldman Sachs, Nomura and Citi are all recommending positioning for a ​steeper curve.

Goldman ‌Sachs, which first advocated the trade in December, reiterated its call after last week's RBI policy decision.

"While ‌the curve has already steepened meaningfully, we still see scope for further steepening in the OIS curve," it said in a note.

Citi said conditions are now ripe for a "re-steepening" of ‌the ​non-deliverable overnight index ​swap (NDOIS) curve.

"We believe factors like lack of a dovish bias in the (RBI) policy statement, upward revisions in inflation, better external outlook due to trade deals.. and hawkish Asian ‌central banks will ​all likely result in re-steepening of the NDOIS curve," Citi added.