Oil shock hammers India bonds before policy minutes, 10-year yield at over 3-year high

Indian government bonds plummeted on Wednesday, with yields nearing a three-year high, as the sharp rise in oil prices sparked inflation worries. Traders awaited the central bank's policy minutes, released after market hours. The benchmark 6.94% 2036 bond yield closed at 7.4427%, up from 7.3920% the previous day. Indian debt markets were closed on Tuesday for a local holiday.

Bond yields have an inverse relationship with prices. Meanwhile, the benchmark Brent crude oil stayed above $110 per barrel and neared $112, the highest in five months, amid concerns over Red Sea shipping risks and threats to Saudi oil infrastructure. India imports almost 90% of its crude, making it highly vulnerable to supply disruptions.

Rising energy costs could fuel inflation, weaken the rupee, and strain government finances. In September, consumer inflation surged to 5.54% and is projected to surpass the central bank's acceptable range in October, according to economists. Earlier this month, the Reserve Bank of India increased rates and altered its stance to "calibrated tightening."

Traders will closely examine the minutes of the upcoming policy meeting for insights into the central bank's appraisal of oil-induced inflation. The sovereign yield curve in India has surged, propelled by the RBI's rate hike, its unexpected shift to "calibrated tightening," high inflation data, tight liquidity due to recent foreign exchange measures, and soaring oil prices.

Upasna Bhardwaj, Chief Economist at Kotak Mahindra Bank, anticipates the 10-year bond yield to range between 7.25% and 7.50% in the short term. Swap markets price in approximately 100 basis points of rate hikes over the next 12 months. India's overnight indexed swap (OIS) rates corresponded with oil prices and Treasury yields, with the 1-year OIS ending 6 basis points higher at 6.59%, while the 2-year rate rose 5 basis points to 6.66%, and the liquid 5-year rate settled at 6.84%.