Traders Await RBI Stance as India Rate Cut Seen as Done Deal

Updated on
  • Bond market expects a 25bps cut in benchmark rate Wednesday
  • Room to further ease monetary policy limited as taper looms

With the bond market having pretty much baked in a quarter-point cut in interest rates, the question investors are asking is whether the Reserve Bank of India will keep the door ajar for further easing when it reviews monetary policy on Wednesday.

While record-low inflation has bolstered expectations for the RBI to cut borrowing costs this week, the prospect of more such moves may be limited as global central banks prepare to shift toward tighter policy, traders say.

“The market is pricing in a 25-basis point cut for now, and a small probability of another reduction down the line,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. “The RBI’s commentary on inflation will be key as it would help determine the terminal rate expectation.”

The following charts highlight how rates traders are positioned going into the Aug. 2 meeting.

One-year forward swap contracts, in which rates to be exchanged are agreed on 12 months in advance, have fallen 62 basis points since reaching a 14-month high in May. The key is whether the RBI will keep space for further easing, said Killol Pandya, Mumbai-based head of fixed income at Peerless Funds Management Co.

“If that happens, the 10-year yield will slide to 6.30 percent level immediately” from 6.46 percent on Tuesday, he said.

The six-member monetary policy committee will lower the repurchase rate to 6 percent from 6.25 percent, according to 41 of 57 economists in a Bloomberg survey. The rest see no change. The reduction would bring the benchmark rate to the lowest since 2010.

Benchmark sovereign bond yields have closely tracked inflation in India. Consumer price inflation fell to a record 1.5 percent in June, adding pressure on the RBI to change the neutral stance it adopted five months ago. The 10-year yield fell four basis points in July, despite two open-market sales by the central bank to absorb 200 billion rupees of liquidity.

Read: RBI Bond Intervention No Risk for Market Fixated on Rate Cut

“Bond markets have been well supported since the time the sub-2 percent June CPI inflation print confirmed the sustenance of the downward momentum,” said Madhavi Arora, economist at Kotak Mahindra Bank. “This has further strengthened expectations of a cut in August.”

Lower interest rates, on the other hand, will further squeeze the spread between U.S. and India, which shrunk to 410 basis points last month, the narrowest since February. That, and limited room available for foreigners to buy local debt after last week’s auctions, means overseas inflows could slow.

India’s foreign-currency reserves, two- and five-year offshore swap spreads, and five-year swap rate are the most sensitive to the debt-quota utilization, Amit Agrawal, a strategist at Societe Generale SA in Bengaluru, wrote in a July 24 note.

— With assistance by Manish Modi

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