Indian Bonds Rebound on US-India Trade Deal

Indian government bonds gained on Tuesday, buoyed by a new trade agreement between the U.S. and India. The deal is fueling optimism for a stronger rupee, which could attract more foreign investment.

However, profit-taking and caution ahead of the Reserve Bank of India's upcoming policy decision are keeping the rally in check.

Trade Pact Eases Pressure on Yields

The rally offers a reprieve for bonds, which recently faced heavy selling pressure. The government's federal budget outlined record market borrowing for the next fiscal year, pushing the benchmark 10-year bond yield to its highest level in over a year.

On Tuesday, the yield for the 6.48% 2035 bond fell to 6.7302% by 10:10 a.m. IST, down from the previous close of 6.7662%. The catalyst for the reversal was a long-awaited trade deal announced by U.S. President Donald Trump, which will cut U.S. tariffs on Indian goods from 50% to 18%.

Figure 1: India's 10-year bond yield saw a sharp run-up before easing on the back of the U.S.-India trade pact announcement.

Rupee Strengthens, Boosting Investor Outlook

Market experts believe the trade agreement could have broad macroeconomic benefits. Deepak Agrawal, chief investment officer for debt at Kotak Mutual Fund, noted that the deal is "likely to improve the country's balance of payments gap, strengthen the rupee, increase foreign exchange reserves and attract foreign institutional investors."

The positive sentiment marks a significant turnaround for the Indian rupee. With trade negotiations stalled for most of 2025, the currency had become Asia’s worst performer, falling nearly 5% over the year. Following the announcement, the rupee gained 1.3% to trade at 90.32 against the U.S. dollar.

Focus Shifts to RBI Policy and Liquidity

The rupee's recent weakness had forced the Reserve Bank of India (RBI) into a difficult balancing act, managing liquidity support for the banking system while also defending the currency.

All eyes are now on the central bank's policy meeting this Friday. While the RBI is widely expected to hold interest rates steady, traders will be closely watching for any commentary on its plans for rupee liquidity and future bond purchases.

Swap Markets Reflect Renewed Optimism

The shift in sentiment was also evident in the overnight index swap (OIS) market, where traders began reversing bets made in anticipation of tighter conditions.

• One-year OIS rate: Fell 2 basis points to 5.52%.

• Two-year OIS rate: Dipped 5.75 basis points to 5.6650%.

• Five-year OIS rate: Declined 6.5 basis points to 6.1325%.