Indian bonds rally as soft US inflation eases rate hike bets
Indian government bond yields retreated from a three-week high after milder US consumer price data reduced the likelihood of aggressive Federal Reserve rate hikes, boosting foreign capital inflows.
Indian sovereign bonds gained ground on Wednesday, pushing the benchmark yield down from a three-week high. The rally closely tracked a sharp decline in US Treasury yields, where the 10-year yield dropped below the 4.60% mark. This move followed June US consumer price data that came in softer than anticipated, prompting market participants to scale back expectations for imminent Federal Reserve rate increases.
The repricing of US monetary policy provided immediate relief for Indian debt markets, which remain highly sensitive to global capital flows and dollar funding costs. According to CME Group's FedWatch tool, the implied probability of a 25-basis-point hike at the Fed's July meeting fell to 17%, down from 42% prior to the inflation print. Expectations for a September hike also softened, dropping to 60% compared to 75.1% earlier in the week.
Mirroring the move in US Treasuries, India's benchmark 6.94% 2036 bond yield dropped to 6.7703% as of 10:40 a.m. IST. Because bond yields move inversely to prices, this marked a clear rebound from Tuesday's session, which had seen the yield close at a three-week high of 6.7945%. The shift also rippled through the Indian interest rate derivatives market, with overnight index swap rates easing across the board.
The one-year overnight index swap rate fell 3 basis points to 5.90%. Longer tenors saw steeper drops, with the two-year and five-year rates both declining by 4 basis points to settle at 6.07% and 6.33%, respectively. This broad-based easing suggests that traders are adjusting their domestic rate expectations in line with the more accommodative global backdrop.
What makes the current rally notable is the market's willingness to overlook domestic inflation headwinds. Rising oil prices typically weigh heavily on Indian bonds because of their direct impact on the country's trade deficit and local inflation. However, investors are currently prioritizing global rate dynamics and structural inflow trends over these localized risks.
Foreign capital has provided a strong floor for Indian government debt. Overseas investors have channelled approximately $4.2 billion into Indian bonds via the fully accessible route since June 1. This sustained demand is heavily driven by growing anticipation that Indian debt will secure inclusion in Bloomberg's Global Aggregate Index, a move that would force passive funds to allocate to the country's sovereign paper.
Looking ahead, the technical and fundamental setup points to further yield compression. "Bonds were in an oversold zone after yesterday, and some reversal was on the cards, and with rising chances of a delay in the Fed's rate hike cycle, we could see the yield easing below the 6.75% mark soon," a trader with a private bank said.
