Debt, swap markets rally on hopes of early 2015 interest rate cut by RBI

The domestic debt and swap markets rallied on Tuesday as the Reserve Bank of India (RBI) reinforced expectations of an interest rate cut in early 2015.

The RBI held interest rates steady at its bi-monthly monetary policy review earlier in the day on Tuesday, as widely expected, but said it could ease monetary policy by early 2015 depending on whether inflation cools further and on government efforts to shore up the country's finances.

Stock markets initially extended losses in a knee-jerk reaction to the unchanged policy rates, but soon recovered as traders bet on monetary easing at the central bank's next policy review in February.

The benchmark 10-year bond yield which rose 3 basis points (bps) in the immediate aftermath of the policy review, fell 6 bps on the day to 8 per cent, its lowest level since July 22, 2013.

Traders said they expect the debt and swap market rally to continue in the near-term, though the pace of the rally may slow until there is more clarity on the timing of the rate move.

"The bond market is running ahead, but there's more conviction about policy easing by February," said A Prasanna, economist with ICICI Securities Primary Dealership in Mumbai.

Banking stocks also rallied on rate cut bets while select state-owned banks gained on hopes for large treasury gains due to the fall in bond yields.

The National Stock Exchange (NSE) Bank index briefly turned positive after dropping as much as 0.5 per cent on early trade.

"OIS is pricing in cuts, but that doesn't mean we can't go any lower as everything depends on how fast the RBI cuts which in turn depends on how inflation pans out. I wouldn't pay rates here but bonds definitely offer value," said Kumar Rachapudi, a fixed income strategist with ANZ Bank in Singapore.

"The 10-year bond yield can move to 7.50 per cent once the RBI starts cutting".

In the overnight indexed swap market, both the benchmark 5-year swap rate and the 1-year swap rate fell 13 bps each to 7.06 per cent and 7.67 per cent, respectively.

The two rates had closed at 7.16 per cent and 7.75 per cent, respectively, on Monday.

(Reuters)