Money market positioning for an interest rate hike

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Mumbai: Money market traders are betting that the Reserve Bank of India (RBI) will hike its benchmark interest rate as early as June as rising inflation, deteriorating fiscal situation and higher global rates will force the central bank to change course.

Six months overnight indexed swaps (OIS) an early indicator for traders’ rate expectations have jumped to 6.33 per cent, the highest since May 2017 because many traders now believe that rates are likely to rise. It had dipped to as low as 6.05 per cent as recently as September 28.

“The swaps are pricing for a hike because inflation is likely to be on the way up, global crude oil prices will remain firm and US Federal Reserve rate increases will also push up global interest rates. All in all there is a real possibility of a rate hike in the second half of this calendar year,” said Naveen Singh, senior vice president at ICICI Securities Primary Dealership.

A RBI rate hike will be the first such move by the central bank in four years. RBI had last hikes its benchmark repo rate by 25 basis points to 8 per cent in January 2014. Since then repo has come down steadily to 6 per cent currently. One basis point is 0.01 percentage point.

An overnight indexed swap is a derivative instrument where traders receive a fixed rate of interest rate for giving up floating rate of interest on a note. It can be used to hedge interest rate risk to prevent losses when rates turn volatile quickly.

For example a bank or company can choose to pay the current six month OIS at 6.33 per cent to a corresponding entity in exchange for the prevailing overnight call rate which is currently around 6 per cent.

In this case the bank or company is willing to pay a rate higher than the call because it expects rates to rise quickly. However, if call rates rise sharply or the RBI raises rates then the entity paying 6 per cent now may have to fork out a much higher rate later.

“Market positions have shifted from OIS being received to now being paid as the possibility of a rate hike has increased. RBI has also turned more hawkish in the last monetary policy and inflation trajectory also is on the uptrend. By and large many market players are betting on a 25 basis point rate hike,” said Prasanna Patankar, managing director at STCI Primary Dealership.

In its monetary policy review on December 6, the monetary policy committee (MPC) of the RBI pointed to the higher food and fuel prices and firming household inflation expectations. Higher input costs, farm loan waivers by select states and decrease in revenue on account of reduction in GST rates could also cause fiscal slippage fuelling inflation, RBI had said, while reiterating its commitment to keep headline inflation close to 4 per cent on a durable basis.

The next RBI monetary policy review is on February 7 and even though a rate hike is not on the table recent inflation numbers have made traders worried. Consumer prices in India rose to a 15-month high to 4.88 per cent in November, latest data shows.

[“Source-economictimes”]