Indian rupee, bonds eye Fed decision, rate outlook

Mumbai, India (Reuters) - The Indian rupee and government bonds are closely watching the U.S. Federal Reserve's decision and outlook for the next rate hike, as oil prices remain above $100 a barrel and the probability of a 25-basis-point increase by the Fed on Wednesday grows. This week, the rupee fell more than 1% against the dollar, closing at 95.55 per dollar on Friday.

The Indian financial markets remained closed on Monday in observance of a local holiday. Brent crude oil stayed above $100 a barrel due to fresh assaults on Saudi energy infrastructure and attacks on ships in the Middle East, raising concerns over potential supply disruptions. Analysts believe the chances of a higher Fed rate hike are high, along with signs of further tightening measures.

Last week's CPI print, which was hotter than anticipated, has all but guaranteed a Federal Reserve rate hike, according to ING. Both factors adversely impact the rupee. However, India's impressive foreign exchange reserves of $785 billion provide confidence that the central bank will intervene to control excessive volatility.

Indian consumer inflation data released on Monday showed that the Consumer Price Index (CPI) stood at 4.82% in August, further supporting the argument for an interest rate increase next month. Along with this, portfolio flows related to global equity index rebalancing and local initial public offerings (IPOs) will be closely monitored throughout the week, alongside the demand for dollars because of maturing non-deliverable forward contracts.

Traders anticipate the rupee to trade within the range of 95 to 95.80. Indian government bonds will likely suffer further losses after the central bank announced an open market sale of bonds worth 1 trillion rupees during the upcoming fortnight. The benchmark 10-year bond yield rose for the fourth consecutive week, reaching 7.0233% on Friday, up 6 basis points for the week.

Traders predict that the benchmark yield will hover between 6.98% and 7.10% and will be influenced by oil prices, the Fed's decision, and the response to the first debt sale due on Thursday. The Reserve Bank of India (RBI) will deploy a potent liquidity-draining tool by selling bonds maturing from fiscal 2029 to fiscal 2032, amounting to 500 billion rupees, followed by 250 billion rupees each on September 21 and September 28.

India's banking system is brimming with surplus cash, as lenders raised a much larger-than-anticipated $127 billion under the RBI's special forex mobilization scheme. This surplus has pushed overnight rates below the floor of the monetary policy corridor. Last week, the RBI utilized two tools to drain liquidity: a longer-tenor variable rate reverse repo and dollar-rupee sell-buy swaps, but both attracted limited interest.

"In the absence of quick and adequate sterilization of liquidity surplus to more sustainable levels, we believe policy rate recalibration would remain ineffective," said SBI Mutual's fund manager Mansi Sajeja.