US midterm results ease pressure, but India rates still seen moving higher

US midterm results may have weakened some of the immediate catalysts pushing Indian interest rates higher, but underlying inflation, fiscal, and global-rate pressures are likely to keep the broader direction of domestic yields upward, according to an Axis Bank report. 

The report said the political outcome in the US could ease some of the faster-moving pressures on Indian rates through potentially lower crude oil prices and reduced demand for funds linked to artificial intelligence (AI). However, slower-moving structural factors—including the convergence of Indian rates with global benchmarks and the Mumbai Interbank Forward Offer Rate (MIFOR), broadening inflation and weakening bank demand conditions—continue to point towards higher rates over time. 

Axis Bank expects the adjustment to be gradual but said Indian rates could eventually move towards levels close to 8%, which have not been seen in years. 

US midterms ease immediate pressure on yields 

Indian bond yields rose sharply through much of October, supported by higher global benchmarks, elevated crude oil prices and signs that inflationary pressures were broadening across the domestic economy. 

The 10-year benchmark yield rose from 7.1861% at the beginning of October to a peak of 7.4740% during the fourth week of the month. Higher crude prices amid geopolitical tensions in West Asia, the Reserve Bank of India's (RBI) policy stance, open market operation (OMO) sales, and pressure from currency forwards contributed to the rise in domestic rates. However, the trend reversed towards the end of October as a pullback in US Treasury yields and an intensifying selloff in AI-linked assets boosted global risk aversion. Strong domestic buying also helped pull Indian yields lower. 

The US midterm election results have added to the recent decline. According to Axis Bank, a stronger political pushback against conflict, tariffs and fiscal dominance could weaken some of the immediate forces that had been pushing global and Indian rates higher. 

Lower crude prices amid expectations of physical oversupply have also provided relief. As of the report's publication, the 10-year benchmark yield had fallen to around 7.17% while the two-year yield stood near 7%. 

Inflation and fiscal pressures remain 

Despite the recent pullback, Axis Bank said the underlying drivers of higher rates remain intact. Domestic inflation is broadening and becoming more generalised even before the full transmission of global shocks, the report said. This raises the risk that inflationary pressures could remain elevated for longer. 

The report also flagged the possibility that India's fiscal consolidation cycle may be nearing its end. The implementation of the next pay commission could add to fiscal pressures in the coming year. 

Meanwhile, deposit growth could weaken following the impact of Foreign Currency Non-Resident (FCNR) flows, potentially reducing the ability of banks to absorb government securities. Limited foreign portfolio investor (FPI) interest could further constrain demand for Indian bonds. 

Global rates and MIFOR to keep pressure on India 

A key concern, according to the report, is the gap between Indian and global interest rates. Current pricing places rupee yields about 0.9 percentage points below US yields on a fully hedged basis, with the gap even wider on an unhedged basis. This is also reflected in MIFOR pricing and could continue to exert upward pressure on domestic interest rates. 

Axis Bank said that while India's domestic economic configuration could justify a lower nominal neutral rate, expectations surrounding the rupee and tight global financial conditions are effectively imposing significantly higher rates on the domestic economy. 

“Without INR depreciation or more controls on capital, this is likely to prevail,” the report said, estimating that the neutral rate being imposed by these conditions could be around 6.50%-7.00%. These pressures are already visible in swap markets, it added. 

Slow climb towards higher rates 

Axis Bank said the US midterm outcome may slow the pace of the rise in Indian yields but is unlikely to reverse the broader trend. “Even though the configuration of the domestic economy might call for a lower nominal neutral rate, rational expectations on the INR and tight global financial markets are imposing much higher levels,” the report said. 

With global financial conditions unlikely to change materially, the bank expects Indian rates to continue moving higher over time, potentially towards 8% levels. However, the journey is likely to be gradual rather than a sharp move, particularly after the recent easing in crude prices, global yields and political risk.