Overnight swap rates hint rate cut hopes ruled out

Overnight indexed swap (OIS) rates, the main financial market tool for gauging the direction of monetary policy, show that derivatives markets have broadly relinquished expectations of rate cuts in 2024 as the central bank continues with its unequivocal focus on bringing inflation down to its target of 4%, which is still some distance away.

“The OIS market has moved towards pricing out all rate cuts in aggregate. There is a hope that maybe there could be nominal rate cuts towards the end of the calendar year, but it isn’t really priced currently,” said Nitin Agarwal, head of trading at ANZ.

“In any case, given the current domestic growth-inflation dynamics and the situation with US economic growth, our market does not expect a deep rate cut cycle,” he said.

On Friday, the one-year OIS rate closed at 6.79% on the Clearing Corporation of India‘s rupee derivatives dealing segment. The OIS market typically prices in a spread of around 20-25 bps over where traders expect the repo rate to be at different time periods. Therefore, the prevailing one-year OIS level indicates that the market does not expect a reduction in the benchmark policy rate, currently at 6.50%.

In early February, the one-year OIS was almost 20 basis points lower, with pricing of different swap contracts reflecting expectations of at least one rate cut of 25 bps in August or October.

Governor Shaktikanta Das said on Friday that while inflation has moderated over the past couple of months and is within the central bank’s tolerance band of 2-6%, the aim was to bring the consumer price gauge to 4% on a sustainable basis. The RBI‘s CPI forecast for the current financial year is 4.5%.

Structural models that the RBI released in its half-yearly Monetary Policy Report on Friday show that inflation is set to ease sustainably toward the 4% mark only in the next financial year. According to the MPR, inflation is seen averaging at 4.1% in FY26 in a range of 3.9-4.3%. The price gauge is seen at 4% in the last quarter of the next fiscal year. CPI inflation was at 5.1% last month.

Das went on to say that India’s robust economic growth gives the RBI room to focus on bringing inflation to the target, implying that the central bank could continue withdrawing monetary accommodation without having to worry about hurting GDP growth.

“The recent re-emergence of reflationary pressures from new supply-side disruptions has posed a challenge to central banks, globally. Against this backdrop, the RBI’s resolute focus on achieving the last mile of disinflation is a very welcome step and will ensure macroeconomic stability,” said Zarin Daruwala, CEO, India & South Asia, Standard Chartered Bank.

Das’s mention of a recent flare-up in global crude oil prices also gave the market a glimpse into the central bank’s wariness over external risks to inflation.

“The RBI has made it very clear that there is no playing around with the 4% target for inflation and that is quite far away when we look at their own projections. Along with a rollback of US rate cut expectations, this is why the OIS market is no longer pricing rate cuts,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership.