Indian government bonds retreated on Thursday in the worst session for the benchmark 10-year bond in over two months, tracking a spike in US Treasury yields as well as oil prices, both of which strengthened bets on a hawkish Reserve Bank of India rate decision in two weeks.
The benchmark 6.94% 2036 bond yield climbed 6 basis points to end at 7.1067%, its highest level since May 21, after closing at 7.0447% on Wednesday. Bond yields move inversely to prices.
US Treasury yields surged to their highest levels since 2007 on Wednesday, after a robust purchasing managers' report reignited fears of stubborn inflation.
Meanwhile, the benchmark Brent crude contract extended gains in Asian hours as diplomatic talks between the US and Iran showed little sign of progress.
India's reliance on imports for roughly 90% of its crude oil needs makes it particularly exposed to swings in global oil prices. Higher crude prices are feeding into inflation worries and raising expectations of a rate hike and potentially further hawkish action by the Reserve Bank of India at its next monetary policy announcement on October 7.
"Liquidity conditions have tightened meaningfully following the central bank's sustained liquidity absorption," said Radhika Rao, a senior economist at DBS.
"The RBI's inflation mandate has likely reinforced the push to drain excess liquidity, with the odds of a rate hike at the October meeting on the rise."
Policy tightening bets in India hardened after August retail inflation came in at 4.82% and the Fed raised interest rates by 25 basis points last week.
Most market participants now expect a repo rate hike by the RBI, with several forecasting a terminal repo rate of 6.00%, from 5.75% earlier.
RATES
Overnight indexed swap rates surged, led by the longer end, moves in which are generally dominated by reaction to oil prices and US Treasury yields.
The one-year rate ended at 6.16% and the two-year rate closed at 6.36%. The liquid five-year rate jumped 9 bps to settle at 6.6350%.
