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Informist, Wednesday, May 7, 2025

By Cassandra Carvalho

MUMBAI – Overnight indexed swap rates ended sharply lower as offshore investors received fixed rates on expectations of a de-escalation in tensions between India and Pakistan, along with bets of at least 50 basis points more of cuts in the Reserve Bank of India's repo rate in the remainder of 2025, dealers said. Domestic traders also unwound some paid contracts at a profit, which they had placed earlier to hedge against geopolitical risk, they said.

The one-year swap rate ended at 5.60%, down from 5.63% Tuesday. The five-year swap ended at 5.56%, also down from 5.63% Tuesday. Total notional trade volumes on the Clearing Corp. of India's derivatives trading platform were INR 284.45 billion, slightly lower than INR 312.90 billion Tuesday. The 1-year and 5-year swap rates closed at their lowest levels in around three years. 

Swap rates were volatile during the day. Most swap rates opened lower as foreign investors received fixed rates, even while domestic traders feared that the conflict between India and Pakistan had escalated after Indian armed forces launched a military operation early Wednesday against nine sites in Pakistan and Pakistan-occupied Kashmir, from where terrorists were suspected to be operating.

Offshore investors may have been receiving fixed rates in early trade after India and the UK concluded a free trade agreement Tuesday, dealers said. Moreover, traders' bets of a deeper rate cut cycle by the Reserve Bank of India's Monetary Policy Committee also led to a fall in rates, dealers said. 

Traders interpreted the media briefing by the government on the airstrikes as a positive trigger for the downward movement of rates. The briefing hinted that India would not take further action unless Pakistan acted in reaction and retaliation from the neighbour was seen as unlikely by the market, dealers said. Following the conference, some domestic traders unwound their paid positions at a profit. Foreign investors continued to drive down swap rates later in the day. The 5-year swap rate fell 8 basis points intraday from the day's high.

Offshore traders prefer receiving swap rates to express their views on India's interest rates rather than buying gilts, as the latter are funded instruments and would require paying a high cost of hedging the rupee, dealers said. Moreover, swap rates are only fully pricing in another 50 bps of repo rate cuts in 2025 to 5.50%, while some traders see the repo rate as low as 5.00% by March, leading to them receiving fixed rates, dealers said.

"Offshore traders were very active, the India-Pakistan thing has now ended," a dealer at a foreign bank said. "Non-deliverable OIS has been consistently lower than onshore, so there is a clear incentive to receive here. My understanding is that both domestic and offshore traders had hedged a lot of their G-sec exposure over the last few days, and everyone unwound that aggressively."

However, swap rates were off their day's lows as some traders paid fixed rates on reports of heavy shelling by Pakistan along the Line of Control in Jammu and Kashmir in retaliation for the Indian airstrikes in Pakistan.

Some domestic dealers were still hesitant to receive fixed contracts since rates have already fully priced in two

quarter-point cuts in the RBI repo rate in the remainder of 2025, whereas traders are still only completely certain of a cut in June, with another likely in either August or October. Traders expect a terminal repo rate of around 5.50%. 

"Onshore investors will only receive at these levels if they expect a terminal repo rate of 5%," a trader at a primary dealership said. "Someone has that view and has taken this position, and there are multiple hedges being unwound."

Dealers said that bond swaps and reverse bond swaps were likely, as traders took advantage of the spread between gilt yields and swap rates, as both markets were volatile during the day. 

OUTLOOK

On Thursday, swap rates will be driven by developments on the India and Pakistan front, dealers said. Traders are on the watch for Pakistan's response to the Indian airstrikes. Traders will also take cues from the US Federal Open Market Committee's rate decision at 2330 IST. Traders do not expect the Fed to cut at this meeting, but await US Federal Reserve Chair Jerome Powell's comments on US President Donald Trump's policies on tariffs, taxes, and immigration and their impact on the US economy.

Caution because of border tensions may deter domestic traders from actively trading in swaps, but activity by offshore participants could spur a movement in rates, dealers said. Traders will track the movement of the overnight Mumbai Interbank Offer Rate for direction on short-term swap rates. The one-year swap rate is seen in a range of 5.45-5.70% on Thursday. The five-year contract is also seen in the 5.45-5.70% range.

End

With inputs from Aaryan Khanna

Edited by Saji George Titus

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