US-Iran Tensions Escalate: How Middle East Conflict Impacts India's Bond Market

Global Markets on Edge as Middle East Conflict Escalates

The ongoing conflict in the Middle East, led by the US and Israel against Iran, has resulted in a significant surge in oil prices, with Brent crude futures increasing by 20% this week. The price of crude has surpassed $86 per barrel, with forecasts indicating it may reach $100 if a resolution is not found.

The impact of the rising oil prices is being felt across the globe, particularly in India, where every $1 increase in crude oil raises the country's annual import bill by approximately $2 billion. The prolonged tensions have also led to disruptions in Gulf shipping routes, with many companies declaring Force Majeure. The Strait of Hormuz, which handles 20% of global daily oil supply and 40% of India's crude imports, has seen oil prices start rallying since Saturday.

The transmission channel of higher crude prices to the economy is clear: higher crude increases inflation risk, which pushes bond yields up and compresses equity multiples. The Nifty 50 index has crashed by over 700 points or 2.8% in the truncated week, but the bond market has surprisingly maintained its ground.

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RBI to the Rescue

The 10-year government yield is currently trading at 6.67%, similar to the levels prior to the start of the US-Israeli war with Iran. The Reserve Bank of India (RBI), along with other participants, has net bought ₹56,000 crore of bonds over the last four sessions, boosting demand even as sentiment remained cautious.

Murthy Nagarajan, Head-Fixed Income, Tata Asset Management, expects the emerging markets to be hit with higher inflation and lower growth. However, he believes the bond markets will be stable amid the crude oil shock, as the RBI and government will work together to minimise the impact by keeping easy liquidity and tapping into their strategic oil reserve.

Investor Strategy

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Investors are advised to focus on fundamentals, as markets will stabilise in the coming month. Those with a longer-term focus should consider investing in short-term and corporate bond funds, due to the attractive carry available in these schemes. Investors with less than 6 months' view should be in ultra/money market or low duration funds.