Overnight index swaps (OIS), India’s main financial instrument for hedging interest rate risk, are currently at a level that suggests there will be no rate cut until around the second quarter of 2025, market participants said.
“The two-year OIS of 6.55% would suggest a rate cut six to nine months from now.June may be a little early, so RBI policy in August or (2024) will give us an outlook on interest rates’ reduction,” PNB Gilts CEO Vikas Goel said.
On Friday, the one-year OIS rate ended at 6.86% and the two-year OIS rate ended at 6.56%, according to data from the Clearing Corporation of India. The 1-year and 2-year OIS are one of the most liquid contracts on the market. OIS rates typically trade at a spread of approximately 25 basis points over the range that market participants expect the benchmark rate to be over time. One basis point is 0.01 percentage point.
While the OIS product removes global factors and is also heavily influenced by movements in US government bond yields, the current pricing means that financial market participants can expect the central bank to reduce the RBI repo rate until it approaches 4%. It shows that you are not betting on. Inflation target.
“For now, we continue to expect the RBI to change its stance in the first quarter of 2025 and initiate a rate cut cycle by the second quarter of 2024. “While we believe this is likely to coincide with changes in the timing of the interest rate cycle (US Fed rate cuts), it is not a given,” HDFC Bank’s financial research team wrote.
According to the latest forecast provided by RBI’s Monetary Policy Committee, consumer price index inflation is expected to be 4% in July-September and 4.7% in October-December of the next financial year. The central bank has repeatedly emphasized that inflation needs to return to 4% sustainably before considering any changes to its current tightening policy.
“While the OIS indicates no rate cuts over the next six months, essentially one-cross-one (rates) one year out suggests there could be rate cuts and some liquidity easing next year. ” said Naveen Singh, Head of Trading, ICICI Securities Primary Dealer.
However, market participants said the OIS pricing signaled that liquidity conditions in the banking system would ease in the coming months. OIS pricing is determined based on the Mumbai Interbank Outright Rate (MIBOR), which is highly sensitive to liquidity conditions.
“One year means that the call rate will be in the 6.25% to 6.75% range fairly soon, suggesting that liquidity is normalizing. Basically, 1 to 2% at the earliest. Within a month. It should be around 6.50-6.60%.’One year of OIS makes sense at current pricing,” Goel said.
A possible acceleration in the pace of government spending at the beginning of the calendar year and expected inflows into bond and equity markets could lead to easing liquidity in the banking system.
Factors such as the RBI’s actions on banks’ cash reserves, currency leakage during the Christmas season, and central bank intervention in the market have contributed to the liquidity crunch since August. As a result, there were several instances where the repo rate was 6.50% and the call rate was around 6.75-7.80%.