Rupee under pressure, bond yields rise on crude, hawkish MPC signals

Benchmark 10-year government bond yield rose to 6.85% during the week, while the rupee weakened to 95.71 per dollar amid higher crude prices and hawkish MPC signals

Government bond yields hardened during the week as the Reserve Bank of India’s (RBI’s) decision to close the FCNR(B) swap window a month early and hawkish signals from the Monetary Policy Committee (MPC) minutes weighed on market sentiment, said dealers. The rupee also came under pressure during the week on the back of rise in crude oil prices and month-end demand for dollar among importers.

 

The yield on the benchmark 10-year government bond settled at 6.85 per cent on Friday from 6.76 per cent at the end of the previous week. The rupee, meanwhile, weakened to 95.71 per dollar during the same period from 95.44 per dollar. On Friday, the local currency was flat against the previous close.

 

 

The benchmark yield, however, softened by 2 basis points (bps) against the previous close of 6.87 per cent.

 

Brent crude oil prices rose by more than 7 per cent to $93 per barrel over the week, supported by continuing supply disruptions and uncertainty around the US-Iran conflict and Strait of Hormuz. On Thursday, it had touched one-month high of $94.71 per barrel.

 

During the week, the pressure was more pronounced in shorter-tenor government securities, particularly the five-year bond, which had outperformed after the FCNR(B) swap facility was announced. The five-year yield rose by 12 bps to around 6.48 per cent during the week. The yield on the short-term bond had hardened by around 10 bps in the first two trading sessions after the RBI announced the early closure of the swap window.

 

Market participants said investors had built positions in five-year bonds expecting FCNR(B)-related inflows to be deployed in securities of a similar maturity, given that the deposits were largely for three- to five-year tenors. The RBI’s decision to advance the closure of the swap facility to August 31 from September 30 has prompted some of these positions to be unwound.

 

The RBI had announced the early closure after strong demand for the facility, with banks raising $52.3 billion through FCNR(B) deposits by August 13. The swap facility was introduced in June to support fresh FCNR(B) deposits by providing banks with concessional dollar-rupee swaps.

 

The impact of the FCNR(B) decision was compounded by the release of the August MPC minutes on Wednesday. While the MPC had unanimously kept the repo rate unchanged at 5.25 per cent and retained the neutral stance, the minutes indicated that some members were increasingly concerned about the outlook for inflation and saw the possibility of policy recalibration if inflation risks materialise.

 

The hawkish tone led to expectations of monetary tightening as early as October.

 

“This was particularly negative for shorter-tenor bonds where yields had benefited from expectations of inflows, and market was not expecting any hike in current financial year after the dovish policy. The minutes came as a shock,” said a dealer at a primary dealership.

 

The rise in bond yields also coincided with pressure on the rupee. The domestic currency remained vulnerable to elevated crude oil prices and dollar demand, although RBI intervention helped limit the depreciation.

 

“Crude oil again inched up to $95 per barrel, and the RBI intervention helped keep the rupee trading around 95.75 per dollar,” said a dealer at a state-owned bank.

 

The rupee is expected to be in the range of 95.50 per dollar to 96 per dollar on Monday.