RBI may cheer markets with softer tone on Wednesday; here’s why

By Subhadip Sircar

India’s rates traders seem convinced record-low inflation and an unexpected slowdown in economic growth will prompt the central bank to soften its hawkish stance when its announces a policy decision Wednesday.

That’s even as some recent surprises by the Reserve Bank of India have caught them on the wrong side of the trade. Another jolt now could cause the one-year forward-swap contract, which is fast converging with the benchmark repurchase rate, to reverse course, and also prompt a rebound in the benchmark sovereign-bond yield, which on Monday headed for its lowest close since February.

<div class='tableauPlaceholder' id='viz1496728783034' style='position: relative'><noscript><a href='#'><img alt='Reverse Repo Rate ' src='https://public.tableau.com/static/images/Re/ReverseRepo-April2017/ReverseRepoRate/1_rss.png' style='border: none' /></a></noscript><object class='tableauViz' style='display:none;'><param name='host_url' value='https%3A%2F%2Fpublic.tableau.com%2F' /> <param name='site_root' value='' /><param name='name' value='ReverseRepo-April2017/ReverseRepoRate' /><param name='tabs' value='no' /><param name='toolbar' value='no' /><param name='static_image' value='https://public.tableau.com/static/images/Re/ReverseRepo-April2017/ReverseRepoRate/1.png' /> <param name='animate_transition' value='yes' /><param name='display_static_image' value='yes' /><param name='display_spinner' value='yes' /><param name='display_overlay' value='yes' /><param name='display_count' value='yes' /></object></div> <script type='text/javascript'> var divElement = document.getElementById('viz1496728783034'); var vizElement = divElement.getElementsByTagName('object')[0]; if ( divElement.offsetWidth > 800 ) { vizElement.style.width='514px';vizElement.style.height='559px';} else if ( divElement.offsetWidth > 500 ) { vizElement.style.width='514px';vizElement.style.height='559px';} else { vizElement.style.width='100%';vizElement.style.height='569px';} var scriptElement = document.createElement('script'); scriptElement.src = 'https://public.tableau.com/javascripts/api/viz_v1.js'; vizElement.parentNode.insertBefore(scriptElement, vizElement); </script>

“Market expectations are for softening of the monetary policy panel’s hawkish tone,” said Nagaraj Kulkarni, a senior rates strategist at Standard Chartered Plc in Singapore. “If that doesn’t happen, then the market will be disappointed and we might see an uptick in bond yields.”

Here are three charts to show the market behavior ahead of the policy meeting:



One-year forward swap contracts, in which rates to be exchanged are agreed on 12 months in advance, have slipped 24 basis points since official data on May 12 showed India’s consumer inflation rate slowed to a record in April. They were at a 14-month high in early May. The central bank will undershoot its fiscal first half CPI target of 4.5 percent by 130 basis points, according to a Kotak Mahindra Bank Ltd. note dated May 24.

“At the beginning of May, the market was pricing the next move to be a rate hike to occur over the next one year,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. “That has been priced out.”



The gap between the 1-year treasury-bill and CPI inflation rates -- an indication of real interest rates in the economy -- is at 346 basis points, the highest since late 2015. The RBI said in October that a spread of 125 basis points was good to be looked at as a neutral real rate, which leaves ample room for the monetary authority to maneuver benchmark borrowing costs.



The RBI will keep the repo rate unchanged at 6.25 percent this week, according to the median estimate of 25 economists surveyed by Bloomberg. Even so, the benchmark 10-year yield fell 1 basis point on Monday to 6.61 percent and was on course for its lowest close since February, driven by expectations of a change in the central bank’s stance. Data that last week showed India’s economy grew at the slowest pace in more than two years in the first quarter has only boosted those expectations and contributed to the decline in yields.