Bond Yields Surge as Crude Oil Crosses $100 Amid Iran War Concerns

Crude Above $100 Fuels Inflation Fears

The main catalyst for the jump in interest rates is the ongoing rally in oil prices. The price of oil has consistently remained above $100 per barrel. The Indian basket is averaging $150 per barrel, which is a steep risk premium.

The situation has further deteriorated as the US, Iran, and Israel continue their hostilities. Although US President Donald Trump postponed the attack on Iran's power plants by 10 days in view of ongoing talks, Iran has denied this. Missile attacks are ongoing in the region.

The disruption has also affected the Strait of Hormuz, which has pushed the price of oil to $119.50, rising by over 60% from the pre-war price of $73 per barrel.

Higher Oil Prices Pressure Bonds and Currency

The high oil prices are also causing high inflation, which usually affects the prices of bonds by lowering their prices. The discount that India traditionally received in oil imports has now become a premium, which could lead to further inflation.

However, the Indian rupee depreciated sharply to a record low of 94.28 against the US dollar after opening 30 paise lower. The rupee had ended at 93 on March 25. The rupee's weakness is adding to the imported inflation risks.

The market players believe that if the tensions ease, the rupee could gain by 1 to 1.5 units.

Domestic Factors Add to Yield Pressure

In addition to these international factors, local conditions are also helping to drive up the yields. Market participants are also keeping an eye on a debt auction to be held by the state government later in the day, in which ₹42,941 crore will be raised. This comes in addition to the ₹12.31 lakh crore in debt sales in the current fiscal year.

In addition to this, the total amount of state debt sales for the week is estimated at ₹57,408 crore.

Rising Global Yields Compound the Impact

The rise in Indian bond yields is also in line with the global bond market. The US 10-year treasury bond has seen its yields rise to around 4.41%. The global bond market has seen significant changes in recent times with an increase in inflationary pressures. 

The European bond market has seen a significant jump in bond yields since the beginning of the Iran war. The UK’s 10-year gilt yields have risen from around 4.2% to over 5%. Similarly, Germany’s 10-year bund yields have risen from 2.65% to over 3%. The French 10-year bond yields have risen from around 3.2% to over 3.7%. The Italian 10-year bond yields have risen from around 3.3% to over 3.9%. 

Short-term bond yields have risen by an even greater margin than long-term bond yields. The rising short-term bond yields, in particular, suggest a bear flattening in bond yields, which is an indicator of an impending slowdown in the economy.

Energy Crisis Deepens Macro Risks for India

As India ranks third in the world in the import of crude oil, it has a major macroeconomic risk in the form of high crude prices.

Furthermore, the import of gas from Qatar, which accounts for 47% of India’s total gas imports, has also been impacted due to the conflict in the region.

RBI Intervention in Focus

With yields increasing and liquidity conditions becoming tighter, market players are watching how the Reserve Bank of India reacts. The RBI has already conducted two auctions of variable rate repo operations for Overnight tenors and is injecting ₹1 lakh crore into the banking system.

If geopolitical tensions persist and inflation risks are high, the RBI may increase its intervention measures to calm bond yields and ensure liquidity in the system.

Outlook

The bond markets are expected to remain volatile in the near term as the conflict between Iran is affecting crude oil prices and inflationary expectations. High oil prices, currency weakness, higher global rates, and high domestic borrowing are factors that are likely to keep pressure on Indian bond yields upward.