India’s overnight swap market pricing in rate cuts before 2023 end

India's overnight indexed swap (OIS) rates are pricing in interest rate cuts by the Reserve Bank of India (RBI) with a clear timeline after the central bank kept rates unchanged last week, analysts said.

OIS rates, often seen as the clearest indication of future policy rate actions, are interest rate derivative products that move as per the expectations of rate trajectory.

"Swap markets are more aggressive in terms of rate cut expectations, as they are pricing in the same from October," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

Analysts add that swaps are now pricing in rate cuts before the end of 2023.

Swap rates plummeted after the Reserve Bank of India (RBI) on Thursday surprised market participants by keeping the repo rate unchanged at 6.50%. Before that, the RBI had delivered six consecutive hikes of an aggregate of 250 bps in fiscal 2023.

The two-year swap rate dropped 25 basis points (bps) to 6.15% since Wednesday's close, which is also its lowest level in eight months.

The more liquid, one-year swap rate plunged 27 bps to 6.53%, while the five-year OIS rate dropped 21 bps in the same period and was trading at 6.05%.

Swaps have witnessed continuous receiving pressure over the past month as turmoil in the global banking sector led to bets that rate hikes may pivot sooner than expected globally.

Since early March, the one-year swap has eased 60 bps and the five-year OIS has eased nearly 70 bps.

"Apart from local factors, swaps also consider global developments, and in the U.S., people are expecting rate cuts to begin in the next few months," said Upadhyay.

Even with the RBI Governor specifying that the current rate action was just a pause and not a pivot, market participants are considering this as an end to the rate hike cycle.

"The two-year swap has already priced in two cuts of 25 bps each in the next one year," said Vijay Sharma, senior executive vice president at PNB Gilts.

Some economists also expect inflation to have peaked and growth to falter, forcing the RBI to pivot soon.

Nomura expects India's annual retail inflation to average 4.9% in the current financial year, sharply below 6.7% in fiscal 2023. It also sees growth at 5.3%, sharply below the central bank's estimates of 6.5%.

"The pause will give way to a policy pivot towards rate cuts, starting October… We expect 75 bps cumulative rate cuts in October-March," Nomura economists Sonal Varma and Aurodeep Nandi said.