Indian government bonds fell on Wednesday after the United States resumed air strikes in the Middle East, widening the Gulf war and driving oil prices and U.S. Treasury yields higher ahead of the Federal Reserve's policy decision.
The United States jointly struck Iran-backed armed groups in Iraq with Saudi Arabia in its first air attacks since suspending its bombing campaign last week, while Tehran rejected an Omani proposal to manage the Strait of Hormuz.
Brent crude futures shot up 4.5% to $88 per barrel and the 10-year U.S. Treasury yield rose 2 bps to 4.62%.
For India, higher crude prices simultaneously pressure inflation, fiscal balances, the current account and the rupee.
The benchmark 6.94% 2036 bond yield ended at 6.7964%, after closing Tuesday at 6.7774%. Bond yields move inversely to prices.
"A more hawkish Federal Reserve or even a renewed debate around further policy tightening, could keep global yields elevated and constrain the scope for significant rallies in both Indian fixed income and risk assets," Axis Mutual Fund wrote in a note.
The Fed's decision is due post market hours, with traders assigning a 65% probability to rates being held steady while fully pricing in a 25-basis-point hike in September.
The Reserve Bank of India's policy decision is due next week, and policymakers are likely to keep the key repo rate unchanged at 5.25%, according to a Reuters poll of economists.
RATES
India's overnight index swap rates rose tracking bond yields, with Fed guidance being the next major trigger.
The one-year swap rate was up 4.75 bps at 5.93%, while the two-year rate added 4.75 bps to 6.1150%. The five-year rate was 5 bps higher at 6.4%.
