Though the Reserve Bank of India left key rates unchanged in its recent monetary policy review, the prospects of deep cuts remain low after the 50 bp of front-loaded cuts last quarter, believe analysts at Credit Suisse.

Ashish Agrawal and Martin Yu of Credit Suisse, in their April 8 research note titled “Asia rates: India – reality check for a few,” point out that the weakness in bonds is temporary.

India: Aggressive expectations of a minority

The Credit Suisse analysts note that India’s central bank, the Reserve Bank of India, left key rates unchanged at its first bimonthly monetary policy review for FY 16. The analysts point out that the RBI’s stance remains accommodative, while its guidance was dovish.

The analysts note that the majority expected no rate cuts at this meeting, though some were anticipating a CRR cut, likely drawing on prevailing liquidity utilization and limited follow-through in lending rates to repo rate cuts.

They point out that during its interaction with analysts, the RBI addressed “aggressive” expectations of the minority when their replies made it clear that expectations of a CRR cut or a move to the reverse repo rate as the operational policy rate were too aggressive, at least in the current environment.

Temporary weakness in bonds

The Credit Suisse analysts note that received positions in offshore OIS segments are most at risk. Positions are likely to be unwound as expectations of deep rate cuts are scaled back and on more certainty that the repo rate will remain the operative policy rate.

Ashish Agrawal and Martin Yu of Credit Suisse point out that the 1y OIS was trading consistent with expectations of a repo rate of around 7.13% or 37 bp of easing in the next year, while received positions in offshore 1y OIS would break even after 50 bp of cuts.

High OIS positioning India

The analysts note while the Reserve Bank of India’s decision was in line with expectations, clarity on overall full-year easing prospects triggered position adjustments. The Credit Suisse analysts say the unwinding saw 10y bonds cheapen 7bp to 7.79% and 5y OIS rates climb 15bp to 6.83%.

The analysts point out also that the weakness in bonds is unlikely to last more than a couple of sessions. They believe bonds have lagged in this rally and potentially offer value even if the RBI cuts the repo rate only once more in this fiscal year. In the near term, rate cut expectations, better liquidity on government spending and lower headline inflation will likely support duration demand. However, the analysts add that over the medium-to-long term, progress on the Reserve Bank of India’s inflation targeting objection should allow for yields to fall further over the coming years.

The Credit Suisse analysts note risks to their view could emerge from any re-emergence of inflationary pressures, which could delay expected easing. They also say that any rapid credit growth could dampen bank demand for government bonds when foreign investors are unable to access markets.

Manageable supply India

The analysts have been long 2019 bonds and 2020 bonds versus 5y OIS and in 2s5s OIS steepeners. The Credit Suisse analysts say the policy announcements reinforce their view and they see little reason to change their stance. The following captures the summary of Credit Suisse analysts’ views:

Summary views India