PremiumIndia’s bond market may have been grudgingly toeing the line of the Reserve Bank of India (RBI) but its swaps are free to rebel and show where interest rates would be.
Overnight indexed swaps (OIS) have surged in the past two weeks even though bond yields have hardly budged. Both the five-year and the two-year swap rates are up by more than 30 basis points while the one-year rate has climbed about 20 bps. One basis point is one-hundredth of a percentage point. On the other hand, the 10-year benchmark government bond yield remained largely steady around 6%.
The trigger point for swaps was the retail inflation print for May which came in at 6.3%, a jump from 4.23% in April. Most analysts now anticipate inflation to stay above the RBI’s comfort zone of 4%, also the mid-point of the 2-6% flexible inflation target for the central bank. The flexibility of the target is giving the central bank room to keep responding to growth compulsions amid a pandemic even though inflation is increasingly getting uncomfortable.
Inflation is climbing across geographies and most bond markets are showing that they don’t like this. Bond yields are climbing albeit faster in some countries and slower in others. In India though, yields have been held hostage by the central bank. The RBI has bought more than ₹3 trillion worth of bonds in FY21 and is expected to continue with its purchases this year too. When its own purchases have fumbled to keep yields low, the central bank has resorted to talking them down. Ergo, yields hardly reflect the inflation pressures.
But this hasn’t worked with swaps. Swap rates have been reflecting the true picture of inflation in India. Longer-term swap rates have hardened even more, indicating that inflation flare-up could be long lasting. “Swaps are showing that there could be multiple rate hikes in quick succession, whenever the RBI begins to unwind," said a trader. As such, economists are predicting rate hikes to begin in the fourth quarter of the current financial year.
The central bank however has stuck to its message of not being in a hurry to unwind. In its latest communique through the monthly bulletin earlier this month, the RBI reiterated its commitment to growth. That said, some members of its monetary policy committee have flagged off the inflation risk, indicating that the window to look through price rise is closing soon.
Never miss a story! Stay connected and informed with Mint. Download our App Now!!