The stock and the bond markets reacted in markedly different ways to Monday’s Index of Industrial Production (IIP) numbers. With the Reserve Bank of India (RBI) likely to ignore the dodgy data and crazy swings in IIP, it seems that the equity markets are factoring in another round of rate hikes. As pointed out in the lead piece in this column, the fact that rate-sensitive sectors such as realty, automobiles and banking fared worse than the broader markets supports that view.
On the other hand, yields in the bond markets fell by 2 basis points (bps). True, the yields slipped before the IIP data was announced, but they consolidated at that level for the rest of the day. Note that bond yields have been steadily declining since the 50 basis points increase in the policy rate on 26 July. Purely based on a market pricing perspective, bond traders are punting on a pause in the rate hike cycle.
Yields in the overnight indexed swap (OIS) market have fallen as well. Remember, the yield curve has been inverted for quite some time now—as early as June in the fond hope of RBI calling a halt to hiking rates—but the spread has widened to 95 bps. It is an indication that the debt markets find the current monetary stance restrictive and repressive.
But that would be too simplistic a reading of the swap market. OIS rates depend a lot on external factors as well. As the events of the past week show, investors are flying away from riskier assets; that includes emerging market debt as well, as the rise in the credit default swaps show. The Greek debt crisis, the US jobs data et al point to a consensus opinion that things are going to get worse.
The fall in the one-year swap was much smaller than the five-year OIS. The one-year swap rate is now at around 7.63%. With the repo rate ruling at 8%, theoretically it means that the markets are expecting RBI to cut rates by the end of the year or inject liquidity. However, with consensus estimates for August inflation numbers at 9.6%, what it probably means is that the debt markets are realistically looking at a 25 bps hike now before a worsening global macroeconomic scenario forces RBI to pull back.
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