Indian Government Bonds Fall as US Fed Rate Hike Expectations and Rising Crude Prices Impact Markets

Indian government bonds fell on Monday, with the benchmark paper slipping into discount. The market movement was driven by hawkish comments from the US central bank chief, which bolstered expectations of an interest rate hike next month, alongside a jump in oil prices above $90 a barrel.

The yield on the benchmark 6.94 per cent 2036 bond was recorded at 6.9480 per cent as of 10:45 am IST, compared to a close of 6.9108 per cent on Friday. Earlier in the trading session, the yield touched 6.9538 per cent, marking its highest level since June 11.

A trader with a state-run bank noted that market sentiment has turned distinctly bearish. Factors including a more hawkish US Federal Reserve, rising crude prices, and the Reserve Bank of India's readiness to act on inflation are leaving little room for yields to ease.

US Treasury yields rose sharply on Friday, led by the policy-sensitive two-year note. The increase followed comments from Federal Reserve Chair Kevin Warsh, who stated that the central bank would still have work to do if officials were not convinced that inflation was moving sustainably toward the 2 per cent target.

Warsh’s remarks were interpreted as a clear signal that policymakers could consider rate increases if inflation remains sticky, boosting bets of a rate hike next month. Markets are currently assigning a 60 per cent probability to a September move, up from 35 per cent prior to the commentary.

Crude oil prices added further pressure to the market. Benchmark Brent crude rose above $90 a barrel in Asian trade after US forces struck Iran’s Larak Island on Sunday, marking the first reported strikes inside Iran since late July.

As an economy that imports the majority of its oil needs, a sustained rise in crude prices could worsen India's inflation outlook and impact government finances. These external pressures align with domestic monetary policy stances. Minutes from the Reserve Bank of India’s August meeting indicated that policymakers remain prepared to raise interest rates if upside inflation risks materialise.

Reflecting these developments, India’s overnight indexed swap rates rose sharply as traders factored in the possibility of a US Federal Reserve rate hike next month. The one-year swap rate stood at 6.02 per cent, while the two-year rate was at 6.22 per cent. Additionally, the most liquid five-year rate jumped 8 basis points to 6.52 per cent.

"The recent movement in Indian government bonds highlights how closely domestic debt markets are tied to global macroeconomic shifts. With US Federal Reserve rate hike expectations gaining traction and crude oil prices crossing $90 a barrel, inflationary pressures are front and center. For businesses and entrepreneurs, these macroeconomic headwinds mean capital costs could remain elevated. Companies must closely monitor interest rate trends, currency fluctuations, and input costs as central banks globally navigate persistent inflation risks." — Dr. Shishir Gupta, Founder & CEO, StartupLanes