Whalesbook
OIS Rates Jump, Diverging from Bond Yields
Indian overnight indexed swap (OIS) rates have experienced a sharp ascent, signaling an aggressive pricing of monetary policy tightening. The one-year and two-year OIS rates jumped more than 45 basis points since February 28, with some tenor rates pushing towards 6.75% in early March 2026. This surge contrasts markedly with the more modest 11 basis point rise in the benchmark 10-year bond yield, which hovered around 6.68% by March 10. The divergence is amplified by a roughly 30% increase in OIS trading volumes, suggesting significant market activity driving these shorter-term rates. Traders attribute a substantial portion of this OIS movement to the rapid unwinding of speculative "received" positions built by overseas investors anticipating ample liquidity and low inflation. As geopolitical tensions escalated and emerging market rates globally rose, these positions were quickly exited, creating paying flows that pushed swap rates sharply higher, effectively adding noise to the market signal.
Inflation Stays Low, RBI Supports Bonds
Despite the aggressive stance priced into OIS, underlying inflation conditions remain benign, challenging the market's hawkish narrative. India's Consumer Price Index (CPI) inflation stood at 2.75% in January 2026, comfortably within the Reserve Bank of India's (RBI) 2%-4% target band and marking the first instance within the band since August of the prior year. Even the RBI's own projections for fiscal year 2026-27 anticipate inflation rising only slightly to 4.0% and 4.2% in the first two quarters, with core inflation around 3.4% in January. Economists suggest the central bank is unlikely to hike rates imminently, especially with retail fuel prices not expected to rise immediately. Furthermore, the RBI has actively intervened to cushion the bond market. On March 9, 2026, the central bank injected ₹50,000 crore as the first tranche of a planned ₹1 lakh crore liquidity infusion for March, purchasing a basket of government securities. This move aims to offset liquidity drained by its foreign exchange operations and stabilize yields. The 10-year bond yield, while reacting to geopolitical news, has been capped by this sustained RBI support.
Global Risks Highlight India's Vulnerabilities
The current market turbulence, driven by Middle East conflict and oil price spikes, exposes India's vulnerabilities. The nation imports over 80% of its crude oil, making it highly susceptible to supply disruptions and price shocks, which directly widen the current account deficit and pressure the Indian rupee. The rupee has already faced headwinds, nearing record lows around ₹92.30 per US dollar in early March. Geopolitical risks, including threats to close the Strait of Hormuz, could further disrupt global energy supplies, potentially reigniting inflation beyond current forecasts. Beyond energy, a significant supply of government bonds, with Indian states expected to borrow approximately ₹5 trillion in the January-March 2026 quarter, adds to the upward pressure on yields. While current inflation is subdued, the potential for price increases, exacerbated by currency depreciation and external shocks, remains a persistent risk. The RBI's continuous liquidity injections, while supportive, also highlight the need to manage the delicate balance between financial stability and monetary transmission.
Market Pricing vs. Economic Reality
Analysts are closely watching the interplay between market pricing and fundamental data. While swap rates are pricing in substantial tightening, many economists contend this outlook is exaggerated given the inflation trajectory. The market's shift is characterized by the pricing out of further rate cuts and the factoring in of potential hikes over the next 12 months, as evidenced by the one-year OIS trading 25 basis points above the repo rate. This environment has led some analysts to recommend trades expecting a wider spread between short and long-term yields on the OIS curve. The RBI's February policy meeting reaffirmed a neutral stance with the repo rate held at 5.25%, suggesting stability but also a readiness to act based on evolving data. With projected real GDP growth for FY26 around 7.4%, the RBI faces a balancing act, aiming to maintain supportive financial conditions for growth while guarding against inflationary pressures, which are expected to see a slight uptick in FY27.