Asia Rates: Rising Indian rates amid higher energy/food prices
In the near term (0-3M), we expect the following drivers and risks to be key in determining the trajectory of Asia ex China swap rates. One, extension of the rise in long-term core/US rates passing through to Asia rates. Two, upside risks to energy prices (production cuts) and food prices (supply/weather-related disruptions) could support market expectations for Asia inflation to reverse its recent moderation trend and the possibility of Asia central banks having to restart rate hikes or at least, sound more hawkish. Three, impact of China growth slowdown, via FX channel, could reduce the scope for outperformance of Asia rates, relative to US rates.
While India is relatively insular to the China factor, our FX Strategists expects USDINR to move into a higher 83-85 range, due to strength in broad USD and scope for some convergence to RMB weakness (for competitiveness reasons). There is little doubt that RBI has ample reserves and would be selling them to cap upside in USDINR, but the higher range would likely still drive some increase of FX risk premium within INR rates. Paying 5Y INR NDOIS would be a good hedge against the risks of higher energy and food prices, as INR rates have one of the highest sensitivities within EM.
While seemingly contrarian against the backdrop of current bullish sentiments on the back of GBI-EM GD index inclusion announced last week, we are comfortable with paying INR rates. We think that market interest to pre-position, via long IGB bonds or receive INR swaps as a proxy, is likely to be low in the near term, due to still elevated uncertainty around the outlook for global duration. Pre-positioning flows are likely to be more apparent only in 1H of 2024, closer to actual inclusion in late June of 2024. In addition, the positivity around index inclusion would primarily support IGB bonds and to a lesser extent, INR swaps. Or put another way, if core/US rates continue to rise, we expect INR swap rates would rise too (less clear for IGB bond yields). The key risks to our view of higher INR rates are a pullback in long-term core/US rates and/or a pullback in energy and food prices.
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