The yield on the 10-year federal bond ended at 8.10% , up from the previous close of 8.06 percent. It had hit a one-month low of 8.03% on Monday.
"Investors anticipate the central bank definitely has something up its sleeve with so much liquidity splashing around," a foreign bank trader said. There were inflows of Rs 200,00 crore ($5 billion) into the banking system after the maturity of a bond on Monday.
The extra cash pushed overnight interest rates down to 4.0-4.25% from 5.75-6.0% at the previous close.
Traders said cash supplies could also be boosted after the central bank was suspected of intervening on Monday to check the rupee after it rose to a nine-year high against the dollar.
Traders speculated the central bank could announce an issue of market stabilisation scheme (MSS) bonds this week to absorb the excess cash. It last sold MSS bonds on May 16 and it usually announces the sale for the coming week on Friday. The Reserve Bank of India has raised the cash reserve ratio (CRR) -- the percentage of deposits banks keep with it -- three times since December by a total of 150 basis points to absorb excess funds which might otherwise stoke inflation pressures. Treasuries dropped, pushing the two-year yield to the highest level since February, after a private report showed US consumer confidence rose this month more than economists forecast.
The report added to evidence consumers will cushion the world's largest economy from slumping home prices and higher fuel costs, allowing traders to reduce bets that the Federal Reserve will cut its benchmark interest rate later this year.
The yield on the two-year note rose 3 basis points, or 0.03 percentage point, to 4.88% at 10:28 am in New York, according to bond broker Cantor Fitzgerald LP. It touched 4.89%, the highest since February 14.