Buying overnight indexed swaps to hedge India bond risk was termed a “widow-making trade” for most of the three years to early 2020, Kiyong Seong, a rates strategist wrote in a note. That’s because interest rate derivatives outperformed government paper amid easy monetary conditions.
However, swap rates have been on an uptrend since the second half of last year. Heavy government borrowing announced in the budget last week and disappointment over the Reserve Bank of India’s support measures have further narrowed the spread between 10-year sovereign debt and five-year onshore overnight indexed swaps to 89 basis points from 125 basis points in end-2020.
“The nation’s growth recovery potential, budget and borrowing plan for next fiscal year, and RBI’s pledge to contain government bond yields and promote a flattening bias in the curve are factors likely to drive a multi-year theme of bond-swap spread tightening,” Seong wrote in the note.
Seong recommends taking advantage of any pullback in recent bond-swap spreads to build up a bond hedge position through paying OIS.