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Bank of America predicts RBI to cut rates by 100bps in two years, contrasting with current market expectations of no cuts.
By Athena Xu
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Bank of America Corp. analysts believe that Indian rates traders have significantly delayed expectations for an interest-rate cut, presenting an opportunity in the swaps market. According to Vikas Jain, head of India fixed income, currencies, and commodities trading at Bank of America, the Reserve Bank of India (RBI) is anticipated to reduce the key policy rate by 100 basis points over the next two years. This projection contrasts sharply with current market pricing, which does not anticipate any rate cuts within the same timeframe. Jain attributes this discrepancy to an overemphasis on geopolitical tensions and an underestimation of local easing price pressures.
Jain predicts that inflation in India will align with the RBI's projection of 4.5% for the year, bolstered by expectations of contained food inflation due to favorable rainfall projections. This outlook suggests a more optimistic inflation trajectory for India compared to global concerns. The two-year overnight index swap rate, which has seen a nearly 40 basis point increase this year amid a global narrative of sustained high rates, is expected to drop by up to 35 basis points over the next year, trading at around 6.65% as of Tuesday.
Despite global market volatility and the repricing of interest rate cut expectations, particularly in the context of hawkish remarks by US rate-setters, Indian assets, including the rupee and sovereign bonds, are viewed as relatively stable. Jain highlights the attractiveness of Indian government bonds, especially in the 5-year to 7-year maturity range, due to positive carry and the RBI's management of liquidity levels. Furthermore, the RBI's strategy to continue accumulating foreign exchange reserves is expected to support the rupee, projected to trade within the 82.5-84 per dollar range this year.
The Indian market's growth and attractiveness have not been without challenges. A lawsuit filed by Jane Street Group against former employees and Millennium Management has cast a spotlight on the competitive and secretive world of high-speed trading in India's options market. Concerns have been raised about the impact of such trading strategies on retail investors, who constitute a significant portion of the market yet reportedly incur losses on derivatives. Despite these issues, the liquidity and opportunities in India's derivatives market continue to draw interest from both domestic and international firms.
"The market has priced out any rate cut for the next two years because of the geopolitical tensions... Even though globally inflation remains a concern, our inflation trajectory seems better and the next move by RBI will be a cut." "Investors should position for a drop in the two-year overnight index swap, which may decline by up to 35 basis points over the next year."
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