Tuesday, June 15, 2021
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Markets pricing in rate cut, despite wary RBI

Investors in India’s markets are betting that Finance Minister Arun Jaitley will persuade a more hawkish central bank to reduce benchmark interest rates as early as next week.

Finance ministry sources have told Reuters that Jaitley will urge Reserve Bank of India Governor Raghuram Rajan to cut rates at the Dec. 2 policy review, fearing that economic growth may have slowed again by dropping to 5 per cent in the three months to September.

“The market is hoping Jaitley wins. A rate cut is partially priced in by the debt market and to some extent in the longer-end fowards,” said Vikas Babu Chittiprolu, a senior foreign exchange dealer with state-run Andhra Bank.

“But there is apprehension about Rajan actually cutting rates. There is a 50-50 view in the market on the rate cut.”

Rajan has resisted calls to cut the RBI’s 8 per cent repo rate for fear inflationary pressures might emerge again, even though consumer inflation has dipped below the central bank’s targeted levels.

Retail inflation slowed to 5.52 per cent in October, well below the RBI’s target of 8 per cent by January, and even below a target of 6 per cent by January 2016.

The bond and swap markets are pricing in a reduction of at least 25 basis points in the repo rate at Tuesday`s policy review.

Yields on benchmark 10-year government bonds have declined 25 basis points (bps) since mid-October, when data showed inflationary pressures receding. Yields on corporate bonds have dropped even more, with those on one-year bonds down nearly 50 bps in the same period.

In the derivatives space, swaps referenced to overnight money market rates have likewise fallen sharply. The one-year overnight indexed swap (OIS) is down more than 45 bps since mid-October, with 20 bps of that move occuring over the last two weeks as investors saw greater chance of a cut.

Traders said that while a rate cut is almost fully priced in at current market levels, there will be a further rally in bonds if Rajan not only reduces rates but also sounds dovish.

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