India's bond market is responding to changing rate expectations influenced by rising inflation and central bank policies, as spreads between swap rates and bond yields narrow while investors brace for possible 2025 rate cuts.

What does this mean?

Investors find themselves balancing expectations for India's interest rates. Rising retail inflation initially sidelined hopes for December 2024 cuts, with the Reserve Bank of India (RBI) maintaining a 'neutral' policy stance. Meanwhile, the US Federal Reserve's softer monetary approach is pressuring India's swaps market. This has led to the five-year overnight index swap (OIS) rate climbing by 22 basis points to 6.18%, while the 10-year benchmark bond yield edged down to 6.78%, compressing the spread to 60 basis points. Financial entities like RBL Bank predict further narrowing as bond demand grows, factoring in a potential 25 basis point cut.

With rate cuts now forecast for 2025, the narrowing spread between OIS rates and bond yields highlights shifting market dynamics. Bonds are anticipated to outshine swaps due to strong demand, and investors should strategize their portfolios to align with longer-term trends.

The bigger picture: A global ripple effect.

India's evolving rate expectations mirror global economic forces shaped by US monetary policy and domestic inflation challenges. As the Reserve Bank of India adjusts its stance in response, the effects could influence global investment flows and economic growth strategies.