Indian government bonds weakened on Wednesday as Brent crude surged above $100 a barrel, rekindling inflation woes and darkening the interest-rate outlook.
Brent crude futures topped $100 a barrel in Asian trade as Washington and Tehran stepped up strikes on ships and key military bases, sharply escalating their six-month-old war.
The benchmark 6.94% 2036 bond yield settled at 6.9568%, 1.5 basis points above Tuesday's close. Bond yields move inversely to prices.
"Sentiment is distinctly negative. If oil remains above $100 per barrel, it could pressure the government's finances," said Debendra Kumar Dash, senior vice president of treasury at AU Small Finance Bank.
Still, the 10-year yield is unlikely to breach 7% in the near term, even if oil holds at current levels, while insurer demand could cushion the long end of the curve, Dash said.
Selling pressure was contained on Wednesday by a large, undeployed liquidity surplus in the banking system.
The surplus surged to a record 11.16 trillion rupees ($117.30 billion) on Sunday, fuelled by stronger-than-expected inflows from the Reserve Bank of India's dollar-attracting measures, and has eased only marginally since.
The RBI has conducted several back-to-back variable-rate reverse repo operations to drain cash since June, but the operations have failed to pull overnight rates back toward the policy corridor, prompting traders to watch for additional liquidity-absorbing steps.
The central bank likely conducted near-maturity dollar/rupee sell-buy swaps on Wednesday to absorb the surplus rupee liquidity, seven bankers said. The swaps were likely for September maturity, with some also pointing to October.
Investors now await signals on U.S. and Indian policy rates. U.S. inflation data is due later this week, followed by the Federal Reserve's decision next week; India's inflation reading is also scheduled next week.
RATES
Oil's break above $100 sparked paying in Indian overnight indexed rates after several sessions of easing.
The one-year rate rose 3.25 bps to 5.9850%, the two-year jumped 4.75 bps to 6.1850%, and the five-year added 4 bps to 6.48%.
