A basis point is a hundredth of a percentage point.
Overnight indexed swap (OIS) rates, the principal financial market tool for betting on interest rate expectations, have fallen by 20-30 basis points in the past month, with their current levels reflecting the start of a policy easing cycle by the central bank in the first quarter of 2024.
“The relevant swap is the one-year OIS, which is hovering around 6.53%. The compounding is around 22 basis points, so effectively the fixing for it to break even needs to be around 6.25-6.30%. If we go with that, then it’s factoring in a rate cut of around 50 basis points (bps) after six months,” said Vikas Goel, managing director of PNB Gilts.
“If the US Federal Reserve delivers a 100 bps rate cut, then it strengthens the case for the RBI to start cutting around February. OIS seems to be saying that in the first quarter, we will have at least a 50 bps rate cut,” he said.
The one-year OIS rate, which closed at a weighted average rate of 6.51% on Wednesday, was at 6.74% a month ago. OIS is a derivative instrument using government bonds as underlying. It is the main tool for hedging interest rate risk in India, with entities swapping fixed rates and floating rates based on their view of where policy rates may be after a certain period.
Global developments, particularly movements in US bond yields, play a major role in influencing OIS rates, sometimes more than domestic factors.
“Yes, the domestic one-year forward points suggest more than two rate cuts starting February, but markets have an action bias and OIS rates are reflecting the global narrative that central banks like the Fed will now move towards an easing regime,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership. “In its last policy, the RBI made it very clear that it is still concerned about food inflation and its own forecasts do not show headline inflation durably going to the 4% target soon.”
Weak US economic data and easing inflation in the world’s largest economy have led to growing market belief that the Federal Reserve will lower interest rates as soon as next month, dragging the US 10-year bond yield down by 21 bps so far in August.
Data released earlier this week, showing a decline in India’s headline retail inflation to a five-month low of 3.54%, has also led to hope that the RBI may signal softer policy in coming months, although the central bank’s prevailing commentary does not suggest so.
The RBI reiterated concerns over food inflation while continuing to project Consumer Price Index inflation at 4.5% for 2024-25, higher than its 4% target.
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