Demand for Indian government bonds faltered on Thursday as looming supply and concerns the Reserve Bank of India could drain more liquidity ahead of possible policy tightening weighed.
Weak demand also hit a Treasury bill auction, pushing yields on 182-day and 364-day bills to three-month highs.
The yield on the benchmark 6.94% 2036 bond climbed 4 basis points to 6.8901% from Tuesday's close. The debt market was shut on Wednesday for a local holiday.
Traders expect the RBI to mop up excess banking-system liquidity through more durable instruments as it positions for tighter policy due to mounting inflation risks.
The banking system's liquidity surplus has averaged more than 3.4 trillion rupees ($36 billion) in August and is expected to surpass 5 trillion rupees in September.
Minutes of the RBI's August meeting showed policymakers were willing to raise rates should inflation risks materialise and broaden. The next decision is due on October 7, with only one inflation print before then.
"The 10-year yield is expected to stay within the 6.85%-6.95% range, as markets are currently pricing in 25-50 basis points of rate hikes over the next 12 months," said Abhishek KS, fixed income fund manager at Abakkus Mutual Fund.
Also testing sentiment is New Delhi's 340-billion-rupee sale of the benchmark note on Friday, alongside unfavourable global cues.
A report on Wednesday showed U.S. July inflation was marginally firmer than economists had forecast, raising expectations of a Federal Reserve rate hike.
Investors now look forward to Fed Chair Kevin Warsh's remarks at this week's Jackson Hole symposium for signals on the policy outlook.
RATES
India's overnight indexed swap rates advanced as sentiment deteriorated.
The one-year swap rate rose 6.75 bps to 5.9250%, while the two-year rate surged 6.75 bps to 6.11%. The five-year rate jumped 8.75 bps to 6.44%.
