One-year overnight swap hints domestic interest rates may be peaking

The one-year overnight swap rate, an indicator of how the Reserve Bank of India (RBI) may act on policy rates, indicates that the domestic interest rate may have peaked, according to dealers. However, it does not signal expectations of a repo rate cut in the next 12 months; rather, it reflects the likelihood of sustained tight liquidity conditions for the foreseeable future.

Overnight Interest Swap (OIS), which are derivative instruments linked to the central government securities market, were initially designed as hedging tools for exposure to government bonds. However, over time, swaps have transformed into instruments used to gauge the trajectory of overall policy rates. A decrease in OIS rates generally indicates anticipated relaxation of financial conditions, whereas an increase signifies that interest rates will move upward.

The one-year swap rate settled at 6.91 per cent on Tuesday. At current levels, traders see the rates having reached a short-term bottom, with potential further decline after any indication of a rate cut by the US Federal Reserve.

“OIS market is saying that interest rates have peaked. It is showing a prolonged pause, and that the tight liquidity is going to persist for some more time,” a dealer at a primary dealership said.

The trajectory of the one-year swap rate is still being guided by domestic money market rates, anticipated to remain elevated over the next few months. The one-year swap rate has fallen by 3 basis points in November so far. On the other hand, the five-year swap rate fell by 12 basis points in the same period as the global indicators, including stable crude oil prices and US yields, have softened.

The market sees the recent decline in swap rates as reflecting a diminishing concern about an impending effective rate hike in India.

“The rate hike expectation which was being indicated earlier is not there anymore,” a dealer at another primary dealership said.

“They should remain the same for the financial year (current),” he added.