Traders Eye Rupee Rally Continuation; Bond Yields Poised for Uptick Amid Global Uncertainties

The Indian rupee had one of its best weeks in over two years. It's gaining ground fast, and market watchers are asking a big question: Can this momentum keep going? At the same time, they're keeping an eye on domestic bond yields, which could start climbing again as global and local economic signals shift.

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Rupee Strength Driven by Dollar Weakness and Foreign Inflows

The rupee closed Friday at 85.2125 against the U.S. dollar, rising 0.3% for the week and jumping over 0.5% in a single day, its best daily move since early 2023. What's behind the surge? Two main things: foreign banks sold off dollars, and traders withdrew from betting against the rupee.

But there's another significant factor at play: the U.S. dollar is slipping. It lost 1.8% last week after investors grew wary of former President Donald Trump's talk of new tariffs. His push for taxes on EU goods and foreign-made smartphones shook confidence in the U.S. trade direction and sparked fresh doubts about where the Fed is headed on interest rates.

"Markets are starting to factor in more trade barriers and a weaker dollar if Trump comes back," said Rajeev Batra, FX Strategy Head at Axis Capital.

Forward Premiums and RBI's Policy Expectations Add Pressure

There's more happening under the surface. Dollar-rupee forward premiums, basically bets on where interest rates will go, have dropped. The 1-year implied yield fell below 2% for the first time in two months.

Why? There are two big reasons. First, many expect the Reserve Bank of India (RBI) to cut rates again soon, maybe by 25 basis points, in their June 6 meeting. Inflation is under control, and growth forecasts are being revised downward. Second, there's uncertainty over the Fed's next moves, especially with weaker U.S. economic data.

Nomura, a Japanese bank, expects India's repo rate to drop to 5.00% by 2025, down from today's 6.25%. They point to slowing domestic demand and mild inflation as key factors.

Bond Market Watch: Yields May Inch Higher

India's bond market is getting jittery. Usually, when the RBI cuts rates, bond yields fall. But right now, there's a risk they might creep higher in the short term.

Last week, the RBI announced a ₹2.69 trillion dividend payout to the government. That's a solid chunk of cash, but just shy of the ₹2.75 trillion markets were hoping for. Some traders had their fingers crossed for a bit more to ease concerns about the heavy bond supply.

Other worries? There's a big wave of government borrowing ahead. If inflation flares up again, especially with global oil prices staying above $83 a barrel, the RBI might pause on rate cuts.

"Crude's still pricey, and tensions abroad haven't eased, so we could see 10-year bond yields spike temporarily," warned Anita Deshmukh, Debt Strategist at Kotak Mahindra Bank.

Upcoming Economic Data to Guide Markets

This week's economic calendar is packed, and markets are paying close attention. India's GDP numbers for January to March are due on May 31, with growth expected to slow to 6.7%, down from 8.4% in the last quarter.

Another key figure to watch is the April fiscal deficit. This report will explain the government's spending ahead of the Union Budget in July. If the deficit is higher than expected, it could increase bond yields, even if inflation stays below the RBI's 4% target.

Globally, U.S. data on inflation (PCE) and GDP will also play a role. These numbers could sway investor sentiment and impact capital flows into countries like India.

Rupee Outlook: Mixed Sentiment Amid Volatility

Despite recent gains, the rupee is still down 0.3% this month. It's not keeping up with some of its Asian peers; Indonesia's rupiah and Thailand's baht are both up more than 1% in May. The rupee has been weighed down by ongoing demand for dollars, mainly from importers.

"Unless we get steady foreign investment in Indian markets and a sharp drop in oil prices, the rupee will likely stay in a tight range," said Prakash Acharya, FX Analyst at HDFC Securities.

Foreign investors have poured over ₹18,000 crore into Indian stocks this month, but bond investments are lagging. Investors are cautious and unsure whether real interest rates and currency stability will hold.

Conclusion: Traders Brace for a Volatile Week Ahead

Traders are bracing for a choppy week. Between the RBI's June 6 policy meeting and critical data releases on GDP and the fiscal deficit, markets could see some wild swings.

India's economy still has solid fundamentals, and foreign stock interest remains strong. But let's be honest, there are plenty of outside risks. U.S. political uncertainty, stubborn oil prices, and China's slowing growth could all throw a wrench in the works.

So, while the rupee's showing strength now, this story is far from over.