The yield curves are one of the most interesting and sought after information/direction provider for dealers, analysts and economists in particular. Liquid yield curves of countries such as of the United States serves as a leading indicator of the state of the economy and is used for various analysis by economists.
The Indian yield curve is an illiquid curve, it is liquid only at some specific tenor points, like the G-Sec curve at present is liquid at tenor points 7, 10, 11 years and semi-liquid at 5, 16 and 30 year points. Among the Indian swap curves only the OIS curve is liquid and that too at only three tenor points, i.e. 1, 2 and 5 years.
For quite some time now the Indian G-sec curve has been inverted at 5y-10y (a spread of around 10 basis on an average), which reflects that the market is worried about inflation and liquidity in the shorter to medium term but does see inflation cooling with time and expects the growth also to slowdown, which was recently supported by the lower GDP growth numbers. From the current hawkish stance of the RBI it is pretty much clear that the central bank is ready to sacrifice growth in order to tame inflation. Inflation on the other hand is at elevated levels due to high oil and other commodity prices, which are bound to come down once the effect of QE3 subsides. A faltering U.S economy, an inflation struck Chinese economy and a debt ridden Europe signals towards cooling of commodity and oil prices. These signals can eventually lead to an overall slowdown in the global economy; it will again be a challenge for emerging economies to handle volatile capital inflows in such a scenario, given that the emerging economies are not battling with high inflation even then. There is also a possibility that there might be no volatile capital inflows in the emerging markets in case of a faltering U.S economy and Europe problems, as the last time QE3 was a major driver of the inflows coupled with low interest rates in the developed economies. It will be interesting to see how the future unfolds, will we have a QE4 from the Federal Reserve’s in case the U.S recovery falters further and where will the hot money flow, are questions best answered by economists I guess.
Coming back to yield curves the Indian OIS swap curve inverted recently, the 1y-5y swap rates have had a spread of around 5 basis. This was mainly because of an expectation of short term rates rising dramatically due to advance tax outflows, as daily liquidity is already in the negative 50-60K Crs according to the LAF window. Also, the 5 year OIS rate has dropped more than the bond yields have, which shows that there are people willing to receive a swap. When a person is willing to receive a swap in layman terms I infer that one sees interest rates coming down, which again supports the G-Sec yields as they reflect a lower inflation(lower crude prices), growth number and hence lower interest rates in future. Also the global picture of a slowdown justifies the flurry of people ready to receive an OIS swap in the long term and pay a swap in the short term.
Kindly do post your feedback as I have written some “financial gibberish” which needs to be refined.
