Part of the overnight indexed swaps curve, a measure of future policy rates, may steepen as investors discount a more aggressive-than-expected stance from the central bank, BofA Securities said Friday.
BofA expects the Reserve Bank of India to raise interest rates by 25-35 on September 30 and believes that the key rate will reach 6.5% by the end of 2023, much later than what some investors expect.
The forward OIS curve to 6 months calculates two rate hikes of 60 basis points in the next two RBI meetings, which should bring the key rate itself above 6.5% in December.
“Inflation and growth indicators (follow) follow below RBI’s projections, increasing the likelihood of disappointment at the next meeting,” the research firm said.
The central bank is meeting next week, with a slim majority of economists expecting a half-point increase in a Reuters poll and a few others a smaller increase of 35 basis points.
BofA pointed out that inflation has been in line with the RBI’s projections so far this quarter. And in its previous policy meeting, the RBI had maintained its growth forecast for the current fiscal year.
The research firm recommends entering into a 3-month undeliverable OIS 1-year, 5-year steeper trade.
In support of trading, BofA emphasized that the 5-year portion of the OIS curve underpriced fiscal risks.
“(The) 5 year prices in a fixed policy rate profile after rapid rate hikes, but a steeper curve would fully reflect the term premium for fiscal risk,” it said.