8%? Axis Bank Whispers A Number India's Bond Market Hasn't Seen In Years

India's bond market has already had a rough few weeks, and Axis Bank thinks the worst may not be over. In its daily brief dated Oct. 28, the lender's research team flagged a number Indian debt markets have not seen in years. "Though not immediate, a path to 8% India yields might be opening," the bank wrote in its monthly spotlight on rates.

The call lands with the benchmark 10-year government bond yield already near 7.47%, its highest since March 2023, according to Trading Economics data on Wednesday. That leaves 8% roughly 50 basis points away. The 10-year last traded at that level in 2018, when it peaked near 8.18% in September.

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The 8% view sits alongside a broader shift in the bank's macro outlook. "Inflation might be looking sustainably higher going ahead," Axis Bank said in the same note.

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That is a meaningful change in tone. India spent much of the past two years with inflation running below the RBI's 4% target, which allowed the central bank to cut rates. Retail inflation has since climbed to 5.54% in September from 4.83% in August.

The Reserve Bank of India has already turned towards the hawkish side. On Oct 7, its Monetary Policy Committee raised the repo rate by 25 basis points to 5.50%, its first hike in years, and shifted its stance to calibrated tightening.

Three pressures pushing yields up

At the foremost is the West Asia conflict, and the resultant surge in crude oil prices. Brent crude traded above $115 a barrel on Wednesday, close to four-year highs. Prices jumped after reports that the US had asked Gulf nations to prepare for a fresh campaign against Iran after the midterm elections. India imports close to 90% of its oil, so every spike feeds into inflation, the rupee and the fiscal math.

The second is a global rate hike cycle, as India is not tightening its monetary policy alone. The Fed's last move was a hike to 4%, the ECB raised rates to 2.5%, and Axis notes markets are pricing an RBA hike next week after Australian inflation came in at 4.3%. The note also flags the US 10-year Treasury yield rising back above 5%, which raises the global floor for borrowing costs.

A liquidity squeeze at home is the third factor flagged by Axis. The lender says banking system liquidity has tightened "markedly towards a zero position." Festive-season cash withdrawals and the RBI's dollar sales to defend the rupee are both pulling money out of banks. The result, the bank warned, is that funding conditions "are likely to worsen further, over and above any rate recalibration in play."

The last time India's 10-year crossed 8%, the backdrop looked familiar. In mid-2018, rising oil prices, Fed hikes and a sliding rupee pushed the yield above 8% for the first time since 2015, and the RBI responded with two rate hikes that year.

The parallels today are hard to miss, with oil near four-year highs, a hawkish global central bank cycle, and a rupee that Axis says the RBI is defending near 95.25 per dollar.

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What 8% Would Mean

This would adversely impact borrowers, as repo-linked home loans have already started resetting after the October hike. Higher bond yields also lift banks' cost of funds, which feeds into MCLR-linked loans and new fixed-rate offers.

On the flip side, savers stand to benefit. Axis expects the gap between deposit and credit growth to widen again as cash leaves the system. Banks competing for deposits usually means better fixed deposit rates.

For the government, a higher 10-year yield raises the cost of every rupee the Centre and states borrow, at a time when costly oil is already straining public finances.

Debt fund investors will also be on the watchout, as bond prices fall when yields rise. Long-duration and gilt funds are the most exposed, while short-term funds are better placed to reinvest at higher rates.

The next test for the bond market comes tonight, when the US Federal Reserve announces its decision at 11:30 pm IST. Axis does not expect a hike, but cautioned that "language is important." 

Beyond that, the RBI's December policy and the oil market will set the pace. Axis is careful to say 8% is not imminent. But with yields already at three-year highs, the distance to that number is shorter than it has been in years.

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