Crude Oil Prices and US Federal Reserve Policy to Guide Rupee and Bond Markets

MUMBAI — Soaring crude oil prices and the upcoming United States Federal Reserve policy decision are set to act as the primary drivers for the Indian rupee and government bonds this week. Domestic liquidity conditions pose an additional challenge for debt markets amid a complex macroeconomic environment.

The local currency settled at 94.94 last week, showing little change from the previous Friday after touching a six-week high of 94.30 per dollar. The rupee had previously strengthened following a series of currency-supportive measures announced by the central bank.

However, market participants remain divided on the long-term efficacy of these recent interventions. Carl Vermassen, a portfolio manager at Vontobel, noted that unlike a rate hike, the latest measures may not foster long-term confidence. Vermassen added that given the changing inflation picture, strong growth, geopolitical environment, external balance challenges, and the fragility of the rupee, changing tack at the level of interest rate policy was timely.

A sharp surge in oil prices and broader risk aversion weighed on the currency late last week, and both factors are expected to remain in focus. Benchmark Brent crude has held well above $110 a barrel, keeping overall risk appetite fragile and raising concerns over India's external finances as the Reserve Bank of India attempts to stem losses in the rupee.

The Fed's policy decision represents another critical hurdle. While markets generally expect a policy pause, investors will closely monitor the central bank's commentary for clues regarding further rate hikes later this year. Any hawkish shift could drive US yields and the dollar higher, adding further depreciation pressure on the rupee.

Meanwhile, Indian government bonds could face continued mild selling pressure. Elevated oil prices are fueling expectations of a larger rate hike in the coming weeks, which continues to dampen investor sentiment.

Traders anticipate the benchmark 10-year yield to fluctuate within a range of 7.41% to 7.50%. India's benchmark 10-year bond yield rose 9 basis points last week, marking its tenth consecutive weekly rise to close at 7.4740% on Friday. The yield has surged a total of 62 basis points over the previous nine weeks, extending its longest-ever run of weekly increases based on data available since 1998.

Sentiment in the bond market has weakened since the domestic central bank raised the policy rate, altered its policy stance, and followed up with hawkish commentary from Governor Sanjay Malhotra. Expectations for a 50-basis-point rate move in December have increased as the central bank is anticipated to utilize interest rates as a defense mechanism to protect the rupee.

Aron Hurd, a senior currency portfolio manager at State Street Investment Management, stated that expectations point to two to three more policy rate hikes in this cycle, which will help address the situation. Hurd described policy tightening as the appropriate response to recent exogenous shocks.

Looking ahead, several key domestic and international data releases are scheduled for the week, including US durable goods, consumer confidence, and new home sales data on Tuesday. The Federal Reserve interest rate decision is slated for Wednesday evening, alongside September industrial output figures. Later in the week, reports will cover September personal consumption expenditure, July-September GDP advance estimates, initial weekly jobless claims, and September fiscal deficit data on Friday.

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