Broadening inflation, Fed prompts traders to ramp up October India rate hike bets

Traders are increasingly betting on an October rate hike by the Reserve Bank of India, with surging oil prices and broadening inflation strengthening the case for tighter policy, while an expected Federal Reserve hike adds to the pressure, four traders said.

The one-year overnight index swap rate rose 8 basis points on Tuesday to 6.11%, its highest since early June, while the five-year rate jumped 11 bps to 6.68%.

The one-year OIS is pricing in at ‌least three 25-bps ⁠rate hikes ⁠over the next year, traders said. The less-traded one-month OIS, a more direct gauge of October rate expectations, rose 10 bps to ​5.34%.


At 5.34%, the one-month OIS implies a meaningful probability of a 25-basis-point hike, although the pricing understates the odds considering ​that overnight rates are running below the repo rate amid surplus liquidity, traders said.

OCTOBER MEETING "LIVE"

All four traders, who declined to be identified because they were not authorised to speak to the media, said an ​October RBI rate hike was almost certain, while some economists have brought forward ⁠their calls ‌to the Oct. 7 meeting.

Analyst at Citi, in a note on Monday, ​said an October ​rate hike "is now its base case", bringing forward its call from December amid a ⁠less favourable inflation outlook.

India's core inflation momentum has strengthened sharply, ​it said, with the August print more than double the two-year average, which raises ​concerns of demand-side pressures emerging.

It expects September inflation to rise to 5.7%, near to the RBI's 6% upper tolerance limit, making it harder, in Citi's view, for the central bank to keep rates unchanged.

Deutsche Bank has made a similar shift, bringing forward its rate-hike call to October from December. It pointed the acceleration in headline inflation towards 5% and a broadening of core inflation, a robust April-June GDP print ‌against the backdrop of an imminent Fed hiking cycle.

Markets are pricing in more than a 90% probability of a 25-basis-point Fed hike on Wednesday, with expectations for another move ​by December ​running at around 50%.

OIL WOES

The ⁠risk of prolonged energy-price pressures is strengthening bets that the RBI will need to hike rates sooner.

Brent crude is up more than 18% over the past two weeks, hitting nearly $110 a barrel on Monday.

The ​RBI has yet to respond to the oil shock with a rate hike, unlike other oil-sensitive Asian economies that have already tightened policy.

Bank Indonesia raised its policy rate by 50 basis points in May and another 25 basis points in June, while Philippines has raised rates by 50 basis points since June.

Deutsche Bank said relative interest-rate differentials could become increasingly important in sustaining capital inflows, an added reason for the RBI to hike rates.