Rupee under pressure from Fed, oil; bonds at risk of further selloff

The Indian rupee faces pressure this week amid concerns of a potential Federal Reserve rate hike, high oil prices, and the possibility of stronger economic growth boosting bond selling. The rupee recovered 0.2% last week to 95.3775 against the US dollar, after trading within a narrow range of 30 paisa for the past two weeks. The Reserve Bank of India's regular interventions have made traders cautious about a further depreciation of the rupee, while importers' demand to hedge future dollar payments has limited upside potential.

Analysts anticipate a more challenging outlook for the rupee, with the broader trend likely to see further weakening. However, the rupee is expected to remain range-bound until the Reserve Bank of India (RBI) makes a change in its stance. Federal Reserve Chair Kevin Warsh hinted at the likelihood of a rate increase at the September 15-16 policy meeting, should inflation stay above the target level.

This has heightened the stakes for upcoming economic data releases, including the ISM manufacturing survey, ADP employment report, ISM services survey, and August jobs report. Oil prices, represented by Brent crude, have been a headwind for the rupee, with crude prices approaching the $90-a-barrel level. Indian government bonds are expected to trade with a negative bias this week, after the benchmark bond yield reached a two-month high of 6.9108%.

Traders forecast the 10-year bond yield to hover between 6.85% and 6.98%, with particular attention on India's GDP growth figures for April-June, released on Monday evening. A Reuters poll projects growth at 7.1%, down from 7.8% in Q1, but some economists anticipate a higher figure, which could prompt the RBI to tighten monetary policy if inflation rises.

Liquidity in the banking system has averaged nearly 1.3% of deposits in August, raising concerns about the RBI potentially withdrawing cash from the system. RBI's policymakers are open to rate hikes if inflation risks materialize and broaden, according to the minutes of the latest meeting. The RBI governor, Sanjay Malhotra, suggested that evidence of spillover effects could warrant policy tightening, while Deputy Governor Poonam Gupta indicated that the case for a hike might emerge this year.

Despite inflation being within the RBI's target band, central bank officials remain vigilant about upside risks, particularly from high oil prices and other supply-side factors that could trigger broader inflationary pressures.