Informist, Monday, Oct 11, 2021

By Nikhil Patwardhan

MUMBAI – Overnight indexed swap rates, especially the five-year OIS rate, soared because dealers unwound their fixed paid positions tracking a sharp rise in crude oil prices and US Treasury yields.

The five-year swap rate ended at 5.56% against the previous close of 5.48%.

Crude oil prices soared for the third day today as concern over supply-demand mismatch continued to deter investors. The Brent crude oil futures for December delivery were up more than $1.50 or more than 2%. The contract had already risen sharply over the previous two sessions and ended last week with almost 4% gains. Meanwhile, the NYMEX December futures were at a seven-year high.

The recent sharp rise in crude oil prices follows the Organization of Petroleum Exporting Countries and its allies' decision not to increase crude oil output for the rest of 2021 despite an increasing demand outlook. Elevated crude oil prices lead to a higher import bill for large consumers of crude, like India, leading to inflationary pressures and giving the Reserve Bank of India less room to extend its ultra-accommodative policy support. 

While the RBI at its monetary policy review meeting last week slashed inflation estimates by 40 basis points for 2021-22 (Apr-Mar), the recent uptick in global commodity prices led by crude, may lead to a rise in CPI inflation in the near term which has been on a downward trajectory since May, dealers said.

Even the government in its latest monthly economic review said that CPI inflation is expected to sustain its downward trajectory in the coming months, but added that global crude oil price volatility would pose concern.

The CPI inflation data for September will be released after market hours on Tuesday. Dealers would be closely monitoring the data to check whether the recent rise in global commodity prices impacts the September inflation print.  

Meanwhile, US Treasury yields also rose despite the lacklustre jobs report for September because investors continued to dump bonds after employment data for August was revised upwards, prompting some analysts to say that the September data was not as bad as it would have been otherwise.

The US economy added 194,000 jobs in September, well below economists' expectations of 500,000. The 10-year US Treasury yield had fallen initially reacting to the jobs report, but ended higher as the upward revision for August jobs data aggravated fears that the US Federal Reserve could well begin tapering its extensive policy support by as early as November. The yield topped the psychologically-crucial mark of 1.60% and ended at 1.61%. It continued to trade above the 1.60% mark today and was last at 1.61%.

The 10-year US Treasury yield rose 12 basis points over the last week, which will continue to weigh on the minds of foreign investors, dealers said, as 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 to foreign investors.

"Now the global scenario looks slightly different from what it looked like in early September," said a dealer with a private bank.

"The sharp rise in commodity prices is making us stare at sticky inflation and a quicker-than-anticipated policy normalisation of the US has marked a shift in view on rates in the near-term. The five-year rate is, so, is factoring in all this."

While the five-year swap rate soared, the one-year OIS ended only marginally higher with low trade volumes as dealers avoided large bets amid uncertainty over the course of the RBI's liquidity normalisation.

The one-year OIS ended at 4.07% against the previous close of 4.04%.

The RBI on last Friday at its 14-day variable rate reverse repo auction worth 4 trln rupees set the cutoff at the highest possible rate of 3.99%. Dealers interpreted it as the central bank's indication of nudging the overnight rates higher in a bid to set the stage for a hike in the reverse repo rate. However, comments from top RBI officials prompted many investors to believe that a hike in reverse repo rate would only happen in February next year, thus creating uncertainty over the course of the RBI's liquidity normalisation.

"The RBI overall at the statement and the press conference on Friday (last week) sounded very dovish but still the rate at the latest VRRR (Variable rate reverse repo auction) was aggressive," said a dealer with a primary dealership.

"Some sections of the market had feared a reverse repo rate hike while most were expecting longer duration VRRR (variable rate reverse repo operations), but nothing of that happened which was positive but then the aggressive cutoff at the VRRR made everybody uncertain. I guess till we have some clarity on this, trade in the one-year OIS will remain muted, and also because it's already trading above the repo rate of 4%."

The dealer believes that the one-year rate would continue to trade above the 4% mark but in a thin band until further triggers.

The one-year swap rate, which is impacted by the liquidity conditions in the banking system, currently reflects a reverse repo rate hike of 40 basis points. Typically, the spread between the one-year OIS and overnight cost of funds is 25 bps--currently the overnight cost of funds is closer to the reverse repo rate of 3.35%.

OUTLOOK

On Tuesday, OIS rates are expected to open steady as dealers may avoid large bets after recent volatility, especially ahead of the release of the CPI inflation print for September.

Dealers would be keenly monitoring the print to see whether the recent rise in global commodity prices has impacted the CPI print for September.

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

The swap rate in the one-year segment is seen at 3.90-4.10%, and in the five-year at 5.35-5.60%.

End

US$1 = 75.35 rupees

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

Edited by Akul Nishant Akhoury

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