India 10-year bond gives up post-policy gains as oil moves, RBI swap pullback weigh

Indian government bonds retreated for a second consecutive day on Tuesday, erasing gains made following the central bank's policy decision two weeks prior, as high oil prices further exacerbated the effects of the premature closure of a deposit scheme. The yield on the benchmark 6.94% 2036 bond settled at 6.8269%, after closing at 6.8071% on Monday, marking the bond's largest single-day rise in over a month.

On the other hand, the 10-year bond yield had dropped to approximately 6.76% after the Reserve Bank of India's (RBI) dovish policy shift on August 5. On Friday, the RBI disclosed plans to terminate a zero-cost swap facility a month early, effectively ending a hedge provided to banks in June for foreign-currency deposits raised from non-resident Indians.

The early termination of the facility, along with the early closure of the FCNR(B) window, resulted in diminished incremental liquidity support for bonds, according to Nuvama in a recent note. The agency added that bond yields would be influenced more by global and domestic factors, such as elevated Brent crude, US Treasury yields, geopolitical developments, and expectations surrounding the US-Iran negotiations, as well as domestic liquidity conditions and RBI policies.

The benchmark Brent crude contract climbed close to $92 per barrel during Asian trading hours, following the 60-day U.S.-Iran ceasefire's expiration on Monday, with neither party signaling a desire to extend it. Being India's third-largest oil importer, the country is particularly susceptible to oil price fluctuations, as higher oil prices exacerbate inflation, the current account, and the government's fiscal situation.

Overnight index swap rates also rose for a second day, with a bidding bias across the curve, highlighting the impact of the RBI's move on market sentiment. Swap rates have surged by 10-17 basis points so far this week.