Overnight indexed swaps, which are a derivatives instrument using government bonds as the underlying asset, maintained their upward trajectory on Thursday due to concerns of an extended period of monetary policy tightening, said dealers.
The five-year swap rate inched up by 6 basis points (bps) to settle at 6.28 per cent. Over the course of the current week, the five-year segment experienced a rise of 13 bps.
Offshore traders paid fixed rates in the five-year segment because of the prevailing hawkish sentiment among major central banks concerning monetary policy, said dealers.
Bank of England hiked policy rate by 50 bps to 5 per cent on Thursday, against the market expectation of a 25-bp hike. UK headline inflation data for May was stronger than expected at 8.7 per cent.
Moreover, Switzerland’s central bank hiked key interest rates by a quarter-percentage point to 1.75 per cent on Thursday and acknowledged that further rate hikes might be required to combat inflation.
The European Central Bank hiked interest rates by 25 bps to 3.5 per cent on June 15 — the highest since May 2001.
Türkiye hiked its main interest rate from 8.5 per cent to 15 per cent, reversing one of President Recep Tayyip Erdogan’s unorthodox economic policies. The 6.5-point rise was far lower than economists were expecting, but it marked a major shift in policy by his new economic team brought in to tackle rampant inflation. Inflation is almost 40 per cent and Turks are in the grip of a cost-of-living crisis.
Additionally, the US Federal Open Market Committee signalled more rate hikes in the current calendar year, even though the US rate-setting panel kept interest rates unchanged at 5–5.25 per cent in its June meeting.
“A lot of offshore buying was there, and the market is repositioning because the central banks are being very aggressive towards rate hikes,” said a dealer at a private bank.
“And the commentary from Jerome Powell on Wednesday was also very hawkish,” he added.
In his testimony before the House Financial Services Committee on Wednesday, US Federal Reserve Chair Jerome Powell said it was a “pretty good guess” that the central bank would hike rates twice more this year.
“Inflation pressures continue to run high, and the process of getting inflation back down to 2 per cent has a long way to go,” said Powell.
Traders paid fixed rates in longer-tenure segments as they repositioned themselves in response to the prolonged delay in expected rate cuts by the Reserve Bank of India, said dealers.
The rate-cut expectations got pushed to February or the first quarter of the next financial year (2024-25), signalling a significant departure from traders’ initial expectations of a possible rate cut as early as October.
“The market went overboard earlier when it started pricing in a rate cut in October itself,” said a dealer at another private bank.
“Now that the rate cut is out of the window, the repositioning is happening,” he added.
Meanwhile, the rise in shorter-tenure swap rates was limited as compared to longer-tenure swaps because traders refrained from placing large bets due to a lack of significant cues regarding interest rates on the domestic front, said dealers.
“The shorter segments didn’t move because it’s known that neither rate cuts nor rate hikes are happening,” said a dealer at another private bank, adding, “The one-year (swap rate) cannot go to 7 per cent; it should remain around the current levels only.”
Even though traders closely monitor the US interest-rate trajectory, they expect the domestic rate-setting panel to keep the repo rate unchanged at least until the end of the current calendar year and potentially even after that, observed dealers.