The rupee closed at 72.4 a dollar against its previous close of 73.5. The rupee had ended at 74 a dollar in October. The yields on the 10-year bonds closed at 7.78 per cent, down from its previous close of 7.82 per cent.
As yields fall, prices of bonds rise.
In absolute terms, the rupee's gain was the sharpest since September 19, 2013, when it had strengthened by Rs 1.6 against the dollar. The Reserve Bank of India (RBI) was not seen intervening in the market, currency dealers said. The rupee may strengthen some more, riding on the momentum, dealers said, but strengthening beyond 70 a dollar is unlikely.
The local equity markets also rallied on Friday along with global equities amid a possible thaw in the US-China stand-off. The sharp decline in oil prices and pullback in the rupee boosted sentiment as it helped ease pressure on the domestic macro.
The benchmark Sensex rose 580 points, or 1.68 per cent, to end at 35,012. The Nifty50 ended at 10,553, up 173 points, or 1.7 per cent -- extending its weekly gain to nearly five per cent. The gains for the week were the most since May 2016. Last week, the Nifty had ended at a seven-month low.
Market players said crude oil below $73 a barrel had been a big sentiment booster. Brent crude prices have come off by 16 per cent from $86 a barrel a month ago. The waiver granted to India by the US from Iran sanctions further helped sentiment.
Besides, improvement in GST collections and favourable earnings posted by some companies saw investors adding to risky bets.
The rupee was mirroring the sentiment of its Asian peers, which also saw sharp gains against the dollar as the greenback lost against major currencies worldwide. At the close of market hours in India, the US dollar index was down 0.24 per cent to 96.05. The index measures the dollar's strength against major global currencies. Ironing out differences with China on trade issues also led the US dollar to lose up some strength, as investors went easy on their safe haven concerns.
Crude oil prices were trading at $73 a barrel, with the contract for it being down 6.4 per cent this week for a fourth consecutive week. However, Iran sanctions may upset the math once again, but emerging markets are clearly cheering the fall in crude prices.
In Asia, the rupee gained 1.4 per cent against the dollar, closely following the South Korean won, which gained 1.45 per cent against the greenback. Still, the rupee is the worst-performing in the region, having fallen 11.82 per cent year to date.
While currency dealers say banks and oil importers have started taking long positions on the rupee, expecting the momentum to continue, brokerage Morgan Stanley continued to remain bearish on the rupee.
"The tension between the RBI and the government raised investors' concern about the RBI's independency and risks of a steeper curve in India rates. Thus, we remain bearish on the rupee despite the lower oil price having temporarily relieved some pressure on inflation and the currency," Morgan Stanley wrote in a report.
"Our oil strategists continue to see oil prices moving higher in 2019 as oil balance remains tight. In addition, the continued global volatility and widening twin deficits could keep INR under pressure. Our economists see funding pressure as likely to persist and pose downside risks to growth," Morgan Stanley said.
After a sharp rebound from recent lows, experts said, investors should exercise with caution.
"The problems that we were stuck with earlier have not gone away completely. I don't see markets going up dramatically from here. The concerns surrounding IL&FS and NBFC liquidity aren't entirely resolved. These issues are still lingering and could blow up anytime," said UR Bhat, director, Dalton Capital Advisors.
In a report, Nomura said Asian currencies could be gaining against the US dollar on China-US trade concerns easing out and a possible Democratic win in the US mid-term elections. Nomura, while cautious on other Asian currencies, said it would go long on rupee for now.
The data released by the RBI showed that India's foreign exchange reserves were at $392 billion, the lowest since July 2017. The reserves have fallen as a result of the RBI's intervention in the market to give support to the exchange rate. The reserves were at $425 billion in April this year.
The data also showed that the RBI not only intervened in the spot market but also heavily in the forwards market. The net dollar position in the forwards markets of the RBI is in negative now, from being a long $17 billion in April.
"This essentially implies a change of net short of $20 billion from end-March in forwards. The recent spurt in RBI's selling activity reflects increased intervention in forwards, in conjunction with spot," wrote brokerage Edelweiss in a report.
This implies an estimated spot and forward forex intervention of $39.5 billion in the first half of financial year 2018-19 (FY19), which is "possibly a much more significant number" than the brokerage's estimated balance of payment deficit of $25-30 billion for FY19.
This also explains the liquidity deficit and the recent spike in bond yields, which has started correcting on oil prices cooling and on the RBI's secondary market bond purchases.
After buying Rs 360 billion of bonds in October, the RBI plans to buy Rs 400 billion of bonds from the secondary market in November.
The India VIX index fell five per cent to 18.23. Overseas investors pulled out nearly Rs 2 billion from the cash segment, while domestic investors bought shares worth Rs 8.5 billion, the provisional data provided by the stock exchanges showed.
Among the Nifty stocks, 37 gained, while 13 ended with losses. Vedanta, Maruti and BPCL gained more than six per cent each, while Tech Mahindra and Wipro declined more than three per cent.