Intelligentguess

Check this out

It is a Bloomberg grab of the chart displaying the movement (for the last three years) in

a) the 5 year government bond yield; and

b) the 5 year swap rate denoted by the overnight indexed swap (OIS)

in the Indian money and bond markets.

Now we all know that the swap rate is an inter bank rate and hence should have an element of credit risk embedded. The government bond yield should, of course, reflect sovereign rates and is therefore free from credit risk.

This suggests that the swap rates should be higher than the yield on government bonds. In other words the swap curve should trade higher than the government bond curve. This is true for all mature markets.

However our picture above shows that the swap curve has, consistently, traded below the government bond curve.

An anomaly that I have been unable to fathom. What really puzzles me is that bank treasurers have not really used the swap market to fund their liability positions. If they had, this anomaly would have disappeared as quickly as it appeared. Given that bank treasurers are a clever lot, there must be a clear and logical reason for this situation.

Anybody with any ideas on this?

Of late - during the last month or so - the swap curve has caught up with the government bond curve. Is sanity returning? Will the swap curve now trade at a premium - as it should logically do so?

Share This

The Indian Rupee fell sharply in the last hour of trading in Mumbai’s fx market on Monday.

The USD-INR rate which was hovering around 40.60 for most part of the day (after touching an intra day peak of 40.54) closed at 40.80 on clear signs that the Reserve Bank of India (RBI) was active in the markets again.

The Indian central bank’s actions have, of late, become more and more unpredictable. While there was a time when intervention in the fx markets was a given, the central bank had seemed to signal, in recent times, that it has made a marginal shift in its currency policy.

In recent months, it had stayed away from the markets for substantially long periods of time, driven more by its difficulties on sterilizing the liquidity generated by its actions in the fx markets than a desire to witness an appreciating rupee. Given a choice, the central bank would still favour a depreciating rupee.

Monday’s market action (and indeed those on a few other days too) seem to suggest that RBI is willing to intervene at times, if only to mark its presence. If such tactics continue in the future, it would only be a matter of time before it is forced to resort to using extraordinary measures to sterilize the resultant magnetization.

With limited spare capacity on sterilization through issue of MSS bonds, I can foresee the central bank resorting to blunt measures like a hike in the cash reserve ratio.

Of course, a reversal of capital flows would be most welcome from a central banking perspective, something that the RBI has been actively encouraging in recent times.

Share This