India bonds brace for selloff as RBI sales add to oil pain

Indian government bonds faced a significant sell-off on Tuesday as market participants returned from a long weekend to a challenging environment characterized by surging oil prices, rising US Treasury yields, and the Reserve Bank of India's (RBI) planned bond sales to absorb excess liquidity. The benchmark 6.94% 2036 bond could trade within a 7.01%-7.05% range, according to a private-bank trader, as it closed at 7.0233% on Friday, up by 6 basis points over the week. Markets were shuttered on Monday for a national holiday.

Inflation fears were exacerbated by the widening Gulf war, with Brent crude approaching $110 per barrel. The US 10-year Treasury yield breached the crucial 5% level, with Germany's 10-year yield surging above 3.51%, and Japan's 10-year yield returning to 3%. These developments have intensified the global bond selloff ahead of the Federal Reserve's rate decision on Wednesday, as investors brace for a potential rate hike following a surge in US consumer prices in August.

For India, the world's third-largest oil importer and consumer, higher crude prices could exacerbate inflation, widen the import bill, and weaken the rupee. Meanwhile, higher global interest rates strengthen the case for domestic rate hikes. Although Indian bonds largely remained insulated from global pressures due to a banking system liquidity surplus exceeding 10 trillion rupees, this protective shield was breached on Friday when soaring oil prices triggered stop-losses and pushed the 10-year yield above 7% for the first time since June 3.

RBI officials announced on Friday that they would sell 1 trillion rupees ($10.47 billion) of bonds in multiple tranches over the coming fortnight to drain excess cash. Market sentiment soured further following this announcement, with the trader emphasizing that the extent of the bearishness would depend on demand for these bonds and the discount at which the RBI sells them. India's retail inflation in August also accelerated to 4.82%, surpassing the 4.80% Reuters poll forecast and July's 4.45% figure.