While a surge in US bond yields has exerted upward pressure on OIS rates over the past month, market participants said that the heightened degree of vigilance about inflation expressed by the RBI on Friday had given traders reason to consider the possibility of more domestic monetary tightening.
“Even before the RBI’s policy statement on Friday, the swap market was pencilling in a mix of rate hike and tighter liquidity conditions over the course of the next one year. That pricing got extended a little more because of the hawkish fine print of the policy,” said Abhishek Upadhyay, senior economist, ICICI Securities Primary Dealership.
The one-year OIS rate closed at 7.04% on Friday. Overnight indexed swaps, which are derivative instruments based on the government bond yield curve, typically trade at a spread over future expectations of the repo rate. With the repo rate currently at 6.50%, the prevailing OIS rates are pricing in 25-40 bps worth of rate hikes by the central bank, traders said.
“I wouldn’t say that there is an imminent view of a rate hike, but the fear of a rate hike and tighter liquidity conditions is what the swap market pricing is currently reflecting,” Upadhyay said.
Even as the RBI left benchmark policy rates unchanged on Friday, governor Shaktikanta Das expressed concerns over inflation stemming from a fall in kharif sowing for crucial crops such as pulses and oilseeds, low reservoir levels and volatility in international food and energy prices.
With the recent conflict in West Asia – which comes amid no signs of a resolution to the Ukraine conflict – imparting greater uncertainty to global commodity prices, particularly of crude oil, the RBI’s concerns on the international situation assume greater significance.LIQUIDITY MOP-UP
A key factor that could keep short-term OIS rates elevated going ahead is the RBI’s resolve to durably drain the banking system of excess liquidity as it battles inflation.
“The RBI’s comments on existing banking system liquidity are indicative of tighter system liquidity conditions continuing as it stands ready to deploy all its tools to absorb excess system liquidity,” said Achala Jethmalani, economist, RBL Bank.
The benchmark floating rate used in the OIS market is the Mumbai Interbank Outright Rate (MIBOR), which is derived from the interbank call money market. Tighter banking system liquidity leads to a rise in the call rate and therefore short-term OIS rates.
On Friday, Das unequivocally stated that the RBI’s inflation target is 4%, and not 2-6%, which is the inflation tolerance zone permitted to the central bank.