We remain constructive on India rates and continue to express this view through long bond positions. In swaps, we recently recommended taking profits on flatteners and we wait for some steepening before reconsidering re-establishing flatteners or outright receivers, Asia Insights said.
An interesting way to start the year
The RBI surprised markets by delivering an intermeeting 25bp rate cut, taking repo rate to 7.75% from 8%. Although the rate cut was widely anticipated, expectations of its timing were divided between February and April. As such, the inter-meeting move in January surprised even the most bullish of expectations on the street. Indeed, rates markets reacted positively. We expect this bullish momentum to increase in coming weeks. In bonds, we revise down our 10yr year-end target to 7.20% from 7.50%.
Take profits on flatteners as swap curve can steepen tactically
We have been recommending swap flatteners since early 2014 but following this recent rate cut, we took profits on our the most recent flattener position that we initiated in July (DV01: USD3K; entry: -37bp; exit: -79bp including roll; total profit 42bp.
An interesting way to start the year
The RBI surprised markets by delivering an intermeeting 25bp rate cut, taking repo rate to 7.75% from 8%. Although the rate cut was widely anticipated, expectations of its timing were divided between February and April. As such, the inter-meeting move in January surprised even the most bullish of expectations on the street. Indeed, rates markets reacted positively. We expect this bullish momentum to increase in coming weeks. In bonds, we revise down our 10yr year-end target to 7.20% from 7.50%.
Take profits on flatteners as swap curve can steepen tactically
We have been recommending swap flatteners since early 2014 but following this recent rate cut, we took profits on our the most recent flattener position that we initiated in July (DV01: USD3K; entry: -37bp; exit: -79bp including roll; total profit 42bp.
- Valuations: The (ND) OIS curve is now trading near all-time inverted levels. The only time it was more inverted was in August-September 2013. However, that was during a bear flattening that was driven by a 300bp equivalent hike by the RBI (Figure 1). During the previous two rate cut cycles as well, the swap curve inversion took place in anticipation of and towards the early part of the rate cut cycle. The curve inversion as measured by 1yrfwd1yr-1yr and 1yrfwd1s4s – our two preferred ways to look at the curves – is at its widest levels. Therefore, the current risk-reward for holding flatteners appears low.
- Positive surprise on pace of easing: Beyond the unattractive valuations, another reason for our decision to close our flattener position was the positive surprise on pace of easing. If the delivered pace of easing is faster than the pace implied by the forward curve, then the realised carry would be much less than what is implied by the curve. Given the RBI can ease further in coming meetings, the implied carry of flatteners (as measured by the current (ND) OIS curve) may not be realised.
- Seasonality: The third reason to take profits on flatteners is seasonality. In February and March, the very front end typically outperforms as the market tries to price in a seasonal improvement in banking system liquidity in April. Also, the longer end of the curve usually prices in supply concession ahead of next fiscal year’s bond supply, which starts in April.
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