Oil, foreign flows in focus for rupee; bond traders eye rate-hike bets

The Indian rupee is likely to be steady over a holiday-truncated week, with oil prices and foreign portfolio flows in focus, while bond yields could face headwinds from tightening banking system liquidity and growing bets on aggressive rate hikes.

Last week, the rupee posted its best week since March with a 2% gain as the central bank rolled out a series of measures to shore up the local unit. It ended at 94.96 on Friday.

The Reserve Bank of India has made it costlier for importers to hedge future current-account payments, raised the cost for banks of buying foreign currency for certain transactions, and opened a dedicated window to supply state-run oil companies with dollars directly from its foreign-exchange reserves.


The combined impact of these measures, expectations of further steps and the central bank's market interventions is expected to support the rupee. Traders see the currency in a 94-95.50 range in the near term.

Indian financial markets will be shut on Tuesday for a local holiday, while investor focus will broadly remain on developments in the Middle East and how they affect oil prices and foreign portfolio flows into Indian assets.

Brent crude prices touched $110 a barrel for the first time since May on Friday. Jitters about global investments in AI firms are also expected to ripple through the FX market, impacting equity or debt flows.

"Heavily overweight positioning leaves the USD vulnerable to a reversal when sentiment towards AI deteriorates," MUFG said in a note.

BONDS

Indian government bonds could continue facing mild selling pressure as fears of a larger rate hike weigh on investor sentiment.

Traders expect the benchmark 10-year yield to move in the 7.32% to 7.42% range, with an eye on oil prices and any more steps from the central bank.

India's benchmark 10-year bond yield posted its ninth consecutive weekly rise, ending at 7.3789% on Friday, up 8 basis points for the week. It had risen 54 basis points over the previous eight weeks, extending its longest-ever run of weekly increases, according to LSEG-compiled data.

Sentiment has been negative since the central bank raised policy repo rate and changed stance, followed by hawkish commentary from Governor Sanjay Malhotra in a media interview.

"We would not characterise the RBI as significantly behind the curve, but inflation risks remain tilted to the upside. A cumulative 100 bps of tightening by June would help the RBI stay ahead of emerging price pressures while preserving its inflation-fighting credibility," said Krishna Bhimavarapu, Asia-Pacific economist at State Street Investment Management.

After the central bank's commentary, calls for a 50-bps move in December have risen, with the central bank expected to use the interest rate as a defence mechanism to protect the local currency.

Meanwhile, foreign investors will continue to remain cautious after being sellers for last few days.

"India cannot fully decouple from elevated developed-market yields, oil prices and global risk sentiment. Higher global yields affect the relative attractiveness of Indian assets, while higher oil prices and INR depreciation can feed into imported inflation," said Norbert Ling, Head of Fixed Income Portfolio Management, APAC at Invesco.