The ongoing crisis in the West Asia has started to impact on the Indian government bond market, as investors priced in rate hikes due to concerns about inflation from rising fuel prices. The rupee also took another knock, falling to another all-time low of 93.97 against the dollar, down 27 paise or 0.29% from the previous close.
The yield on 10-year benchmark bond hit a one-year high of 6.88% before settling at 6.84%, up 10 basis points (bps) from the previous close. Yields recovered marginally after US President Donald Trump announced a five-day pause in military strikes against Iran. Consequently, crude oil prices have fallen 14% to $ 96 per barrel from its high of $ 114 and it was last traded at $ 103.
Post-market hours, Iran denied engaging in any talks with the US, contradicting President Trump’s claims of recent “productive conversations.”
A breather for the markets
“Trump’s statement is definitely a breather to the market. However, things are still uncertain as Iran denied the claims. Expectations of rate hikes amid inflationary pressures, FPI outflows, and rupee weakness are stressing the bond market. System liquidity has also moved to deficit due tax outflows and forex interventions,” said Madhavankutty G, chief economist at Canara Bank. He expects yield to trade at 6.80% if there is no further escalation.
The system liquidity also turned to a deficit at Rs 65,396 crore as of March 22 compared to an average surplus Rs 2.5 lakh crore in the first two weeks.
“Though market has taken five-day pause as a temporary relief and bond market has already reacted to the news. However, Uncertainty still persists, which will continue to weigh on the market,” said Kumar Viswanathan, head of treasury at ESAF Small Finance Bank.
What will happen if the war persists?
Market participants expect the 10-year yield to touch 7% if the war persists for a long time.
Market is pricing in 1-3 hikes over the next year amid worries over inflationary pressures, which is also reflecting overnigh index swap (OIS) market. One year OIS rates surged by 50 bps 5.98% since the war broke out. Market participants were also worried about potential war escalation after President Trump’s 48-hour deadline for Iran to fully reopen the Strait of Hormuz, which rippled through trading during the day.
Viswanathan added that higher yields raise the government’s borrowing costs. “That was the main reason why the RBI was trying to indirectly intervene by buying in the secondary market. But beyond a certain level, especially considering the fact that rupee is also depreciating, they are not in a position to take it down.” Earlier, the RBI’s bond buying in the secondary market capped the bond yields at 6.75% despite higher oil prices, said traders.
After today’s fall, the year-to-date depreciation in FY26 to 9.96%, the highest in 12 years and the rupee continues to be Asia’s worst performing currency.
“The RBI intervention prevented the rupee from breaching the 94 level. Without their intervention, fall would have been much higher. However, the dollar demand was strong on account of FPI outflows and importer buying,” said Ritesh Bhansali, deputy CEO, Mecklai Financial Services. He said that the rupee will likely open higher at 93.50 followed by the Trump’s statement.
Market participants noted high uncertainty ahead, with oil prices to drive the market.