Indian rupee, bonds eye Fed decision, rate outlook

MUMBAI: Pressure on the Indian rupee is likely to persist this week as oil prices stay above $100 a barrel and expectations of a US Federal Reserve rate hike grow, also weighing on government bonds.

The Indian rupee fell more than 1% last ​week to close at 95.55 per dollar on Friday.

Indian financial markets were shut on Monday for a local holiday.

Brent ‌crude remained above $100 a barrel after fresh strikes on Saudi energy infrastructure and attacks on ships in the Middle East raised concerns over supply disruptions.

Markets are also pricing in a high chance of a 25-basis-point Fed rate hike on Wednesday and expect signals of further tightening.

“Last week’s hotter-than-expected CPI print has all but sealed a ​Federal Reserve rate hike,” ING said in a note, referring to hotter than expected consumer inflation data released Friday.

Both factors are ​negative for the rupee, though record FX reserves of $785 billion have strengthened expectations that the central bank will ⁠step in to curb excessive volatility.

India’s consumer inflation data released on Monday showed CPI stood at 4.82% in August, strengthening a case for an interest ​rate hike next month.

Meanwhile, portfolio flows related to a global equity index rebalancing and local IPOs will also be in focus this week alongside ​dollar demand spurred by maturing non-deliverable forward contracts. Traders expect the rupee to hover between 95 and 95.80.

Bonds

Indian government bonds are likely to witness further selloff after the central bank announced open market sale of bonds worth 1 trillion rupees this fortnight, while a Fed rate hike this week has become a near certainty.

The benchmark ​10-year bond yield posted a fourth consecutive weekly rise, after ending at 7.0233% on Friday, up 6 basis points for the week, adding to ​around 20 bps of jump in the previous three weeks.

Traders expect the benchmark yield to move in the 6.98% to 7.10% range, with focus on oil ‌prices, the ⁠Fed decision and the response to the first debt sale due on Thursday.

The RBI will use one of the most potent liquidity-draining tools, and will sell bonds maturing from fiscal 2029 to fiscal 2032 worth 500 billion rupees, following it with 250 billion rupees each of sales on September 21 and September 28.

India’s banking system is flush with surplus cash after lenders raised a much larger-than-expected $127 billion under the RBI’s special forex ​mobilisation scheme, and this has pushed ​overnight rates below the floor ⁠of the monetary policy corridor.

Last week, the RBI used two tools to drain liquidity: a longer-tenor variable rate reverse repo and dollar-rupee sell-buy swaps, but both drew limited interest.

“In the absence of quick and adequate sterilisation ​of liquidity surplus to more sustainable levels, we believe policy rate recalibration would remain ineffective,” SBI Mutual’s ​fund manager Mansi ⁠Sajeja said.

Meanwhile, Brent crude stayed around $105 per barrel, and the 10-year Treasury yield flirted with 5% levels, as elevated inflation trajectory will push the Fed to hike rates sooner-than-previously anticipated.