Indian government bonds tumbled on Monday, with the 10-year benchmark yield recording its biggest monthly rise of the fiscal year, as elevated oil prices and hawkish signals from the RBI were reinforced by the Federal Reserve.
The yield on the benchmark 6.94% 2036 bond ended at 6.9452%, its highest since June 8, after closing at 6.9108% on Friday. The yield rose 11 basis points in August, its biggest monthly increase this financial year.
Brent crude stayed above $90 a barrel as the U.S.-Iran war entered its sixth month with fresh escalation and no clear end in sight.
For India, a sustained rise in crude prices could worsen the inflation outlook and impact government finances.
Traders said, the first sign of tightening would be absorption of liquidity surplus, that has averaged around 1.4% of deposits in August, through longer duration reverse repos.
In what was seen as a sharp turn from the monetary policy statement, the minutes of the Reserve Bank of India's August meeting showed policymakers remained prepared to raise interest rates if upside inflation risks materialise.
RBI will need to use wider set of liquidity absorption tools, and in case these tools do not prove effective, RBI may advance first rate hike to October from December, said Abhishek Upadhyay, co-head of research at ICICI Securities Primary Dealership.
"While a good part of the core surplus may be offset by seasonal drags, optics around build up of surplus at a time when inflation is picking up is quite poor, and will warrant policy attention."
The 10-year U.S. Treasury yield remained glued to 4.70% handle as the possibilities of a rate hike by Federal Reserve as early as next month jumped.
Fed Chair Kevin Warsh said the central bank would still "have work to do" if officials were not convinced inflation was moving toward 2%, in clearest signal that policymakers could consider rate increases.
Meanwhile, Indian economy grew 7.8% on-year in April-June, above 7.1% Reuters forecast, but sharply lower from revised 8.6% in April-June.
RATES
India's overnight indexed swap rates (OIS) ended a volatile August higher.
The one-year swap rate ended at 6%, and the two-year rate closed at 6.1850%. The swap rates rose 8 bps and 6.5 bps, respectively, in August.
The most liquid five-year rate jumped 7 bps this month to settle at 6.4825%.
