Informist, Tuesday, Sep 28, 2021

By Nikhil Patwardhan

MUMBAI – Overnight indexed swap rates edged higher today because traders paid fixed rates tracking the sharp overnight rise in US Treasury yields and crude oil prices. 

The one-year rate ended at 3.99% against Monday's close of 3.96%, while the five-year swap rate ended at 5.35%, against the previous close of 5.33%

Yields on US Treasury notes rose higher on Monday led by optimism about the economy and prospects of a tighter monetary policy. Yield on the 10-year US Treasury note briefly topped the psychologically-crucial mark of 1.50% before ending largely steady at 1.48%. However, the yield surged today to a near-three month high and was last at 1.53%.

A rise in US Treasury yields narrows the interest rate differential between the safe-haven asset and emerging market debt, making the latter less appealing for foreign investors.

Meanwhile, crude oil prices surged on worries of tight supply in the near-term amid growing demand for the commodity. The Brent crude oil futures contract for November delivery jumped to its highest level since October 2018 after rising more than $1 on Monday to settle at $79.53/barrel and topped the psychologically-crucial mark of $80/bbl. The contract was last at $80.22/bbl.

Typically, a rise in crude oil prices increases upside risks to inflation in India and gives the Reserve Bank of India less room to prolong its monetary policy accommodation.

"US yields are rising, crude is near 80 ($80/bbl) so you would expect some heavy paying and that is what has happened," said a dealer with a private bank.

"US yields are back to where they were in June, so I won't be surprised if the five-year rate goes back to where it was when UST (US Treasury yield) was 1.50% at around 5.45% levels. The one-year rate, I believe would not rise that much, especially ahead of the RBI policy."

The five-year rate has surged nearly 20 basis points over the last three days, mainly tracking global cues, while the one-year rate has gone up 11 basis points during the period.

The one-year OIS rate topped 4% today intraday, which also is the benchmark repo rate of 4%, but dealers expect it to stay within a band of 3.90-4.00% in the run-up to the RBI's monetary policy review, as the market is awaiting any hints whether the central bank would hike the reverse repo rate in the near-term, which could then lead to a sharp rise in the one-year rate. 

Currently, the one-year swap rate indicates a 40-60 bps hike in reverse repo rate, as typically the one-year OIS maintains a spread of 25 basis points over the overnight cost of borrowing, which is the reverse repo rate of 3.35% due to the abundance of liquidity in the banking system.

Moreover, the one-year swap rate is more prone to changes in existing liquidity in the banking system. With the RBI stepping up its variable rate reverse repo operations in the last two weeks, some sections of the market expect the central bank could increase the tenor of such operations.

Meanwhile, several analysts believe that the central bank could also consider narrowing down the gap between the reverse repo rate and repo rate by the end of calendar year by hiking the former, dealers said. Otherwise, the central bank is not seen changing its accommodative stance and is expected to keep benchmark repo rate unchanged, now that the CPI inflation print over the last two months has fallen within its target band of 2-6%, dealers said.

Towards the end of the day, some traders opted to pay fixed interest rates after the central bank set a sharply higher-than-expected cutoff for the 2 trln rupees it had tendered. The cutoff was set at 3.99%, near the repo rate, despite weighted average rate at the auction being 38 bps lower, dealers said.

The market has been caught in a bind as to whether the RBI set the cutoff higher to prompt a rise in overnight fixing rat--which led to paying in swap rates--, or was it the reluctance of some major banks to park their money in variable rate reverse repo ahead of the quarter-end, dealers said.

OUTLOOK

On Wednesday, OIS rates will open steady as dealers may avoid large bets due to the lack of significant domestic cues on rates.

Rates are now seen trading in a narrow band in the near term in the run-up to the RBI's monetary policy meeting scheduled for early October.

Any sharp movement in crude oil prices and US Treasury yields overnight may lend cues at open.

The swap rate in the one-year segment is seen at 3.80-4.00%, and in the five-year at 5.10-5.40%.

End

US$1 = 74.04 rupees

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

Edited by Snigdha Kuttikat

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