Bonds and rupee gain; US inflation spurs hopes of dovish Fed move

Markets feel that US central bank's aggressive rate hike cycle may be nearing an end

Government bonds and the rupee strengthened sharply on Wednesday as a lower-than-expected US inflation print led to hope of the Federal Reserve adopting a less aggressive path for its future rate hikes, dealers said.

The rupee closed at 82.46 per dollar on Wednesday as against 82.81 per dollar on Tuesday. In 2022, the Indian currency has depreciated 9.8 per cent versus the US dollar.

Yield on the 10-year benchmark government fell 5 basis points to 7.22 per cent on Wednesday. Bond prices and yields move inversely. A decline of one basis point in the 10-year bond yield corresponds to a rise in price of roughly 7 paise.

Data released after Indian trading hours on Tuesday showed that the US consumer inflation was at 7.1 per cent in November, marking the slowest pace of increase since December 2021.

The data has stoked expectations of the Fed showing signs that its prolonged and aggressive rate hike cycle may be nearing an end. So far in 2022, the US Fed has raised interest rates by 375 bps and is widely expected to hike rates by 50 bps more late Wednesday.

“USD/INR spot closed 34 paise lower at 82.46, on the back of lower than expected US CPI and hopes that Fed today will signal that rates will peak in Feb/March of next year around 5%,” said Anindya Banerjee, VP--Currency Derivatives at Kotak Securities.

“Rupee remains undervalued to its peers and if the Fed sounds dovish, it can help the rupee appreciate towards 82.00/81.80 levels on spot. We expect a range of 81.80 and 82.80 on spot,” he said.

With the US central bank now seen slowing down, the dollar index weakened past the 104 level on Wednesday. The index was at 103.72 at 3:30 pm IST versus 105.08 the same time on Tuesday. US bond yields also declined sharply, with the 10-year yield dropping around 10 bps.

A softer dollar and lower US bond yields increase the appeal of emerging market assets such as the rupee and domestic sovereign bonds.

“Our 10-year bond yield could go to 7 per cent if the Fed signals a softer approach to rate hikes,” said Naveen Singh, head of trading at ICICI Securities Primary Dealership.

“There are some market signals that suggest a possibility of there being a pause in domestic rate hikes from. So there is definitely room for bond yields to head much lower,” he said.