Govt bonds dip as US Fed move seen as final straw pushing RBI toward hikes

Indian government bonds experienced a decline in early trade on Thursday following the U.S. Federal Reserve's decision to raise interest rates for the first time since July 2023. The Fed also indicated a possibility of additional rate hikes later in the year, which has put additional pressure on the Reserve Bank of India (RBI) to potentially follow suit.

The benchmark 6.94% 2036 bond yield saw a rise to 7.0779% by 10:10 a.m. IST, up from 7.0524% on Wednesday. U.S. Treasury yields mirrored this upward trend, with the 10-year Treasury yield hovering around the 5% mark after the Fed's announcement. The decision to raise rates, the Fed's first such move in over three years, was unanimous among the policymakers.

Market expectations of a rate hike at the Fed's subsequent meeting in late October rose from roughly 50% to nearly 90%, according to CME FedWatch. DBS forecasts that the Fed will hike rates in December and again in early 2027, as the Fed statement suggests stability in growth, consumption, labor market, and productivity, allowing the focus to remain on inflation for now.

In India, investor sentiment has been deteriorating ahead of the RBI's planned open market sale of debt, with the initial tranche set to occur later in the day. The RBI is expected to sell bonds worth approximately ₹1 lakh crore this fortnight, including ₹50,000 crore on Thursday. Analysts have strengthened their bets on an October rate hike by the RBI, with large foreign banks such as Citi and Deutsche Bank advancing their rate hike predictions to October.

A 25 basis points RBI rate hike in October appears increasingly likely, but analysts anticipate a shallow 50-75 basis points hiking cycle, according to Emkay Global. Overnight indexed swap (OIS) rates moved by around 5 basis points across the majority of the curve, reflecting growing confidence in an October rate hike.