Rupee slips, bond yield jumps to 4-month high on hawkish Fed signals

Sovereign bonds and the rupee weakened on Wednesday after Federal Reserve Chair Jerome Powell outlined a more aggressive path for US rate hikes than was previously expected, leading to concerns about capital outflows from emerging markets like India.

While dollar sales by exporters towards the end of the financial year helped the rupee claw back some losses, the yield on the 10-year government bond touched its highest intra-day level since November 4, 2022, as US debt yields surged. Bond prices and yields move inversely.

The rupee settled at 82.06 per US dollar versus 81.92 at the previous close. Intra-day, the domestic currency weakened to a low of 82.29 per dollar before receiving a boost from exporters looking to lock in dollar sales at lucrative levels, traders said. The yield on the most liquid 10-year government bond closed at 7.45 per cent on Wednesday, as against 7.43 per cent on Monday. During the trade, the yield on the 10-year bond climbed to 7.47 per cent.   

The Indian bond and currency markets were closed on Tuesday for Holi.

So far in 2023, the yield on the 10-year bond has jumped 12 basis points (bps). The rise in government bond yields pushes up broader borrowing costs in the economy as sovereign debt is the benchmark for pricing debt issued by corporate entities.

Moreover, in a rare occurrence, the Indian bond yield curve has inverted, with the yield on the 364-day Treasury bill currently 3 bps higher than the yield on the 10-year bond. Under ordinary circumstances, longer-term bonds fetch higher returns to compensate for inflation and growth risks over a longer time frame.

While yield curve inversions in the US are known to be an indicator of an economic recession, the Indian yield curve could instead be reflecting a heightened degree of uncertainty about inflation, interest rates, and tighter liquidity conditions in the banking system, traders said.

 “Short-term rates going up are also a sign of liquidity getting tighter. The market believes that the RBI will also increase rates now. Data on inflation, to be released on Monday, will be crucial. Markets will remain edgy till then,” Bank of Baroda Chief Economist Madan Sabnavis said.

“Theoretically such a phenomenon is seen as heralding a recession. While that is not the case here, a slowdown is imminent,” he said.

According to ICICI Securities Primary Dealership’s head of trading, Naveen Singh, the yield on the 10-year bond could test the psychologically significant 7.50 per cent mark based on two key events – US jobs data on Friday and domestic inflation data due next week.

“It is a challenging situation for emerging markets now. The Fed could hike rates by 50 bps again this month after choosing smaller rate hikes towards the end of 2022. The rate differential between India and the US is set to become narrower,” Singh said.

While delivering his semi-annual testimony before the Senate Banking Committee on Tuesday, Powell said that the latest US economic data were stronger than expected, suggest the final level of interest rates could likely be higher than previously expected.

Higher US interest rates typically prompt global investors to flock to the world’s largest economy, thus leading to strength in the dollar and exerting pressure on emerging market currencies. The dollar index, which measures the currency against six rivals, was at 105.68 at 3.30 pm IST, as against 104.60 at the same time on Monday.

In a bid to bring down high inflation, the Fed has hiked interest rates by 450 bps since March 2022, marking its most aggressive tightening cycle in around four decades.