The Indian rupee had just hit a six-week high before suddenly facing a stress test. Global capital is flowing into safe-haven assets such as US Treasuries and the Japanese yen, while Brent crude is approaching $115 per barrel, squeezing this heavily energy-import-dependent economy from two directions at once.

At Friday's open, traders expect the USD/INR pair to trade in a range of 94.84 to 94.88, after closing the previous session at 94.8175. Just one trading day earlier, the rupee had briefly risen to a more than six-week high near 94.30, before quickly giving back those gains.

Bankers said the speed of this reversal and its divergence from broader market moves caught the market off guard, further increasing uncertainty over the rupee's outlook. Caught between accelerating safe-haven flows and persistently rising oil prices, the pressure on the rupee is building.

Safe-haven trades return, Treasury yields and equities turn together

The direct trigger for this round of risk aversion was market doubts about the outlook for AI spending.

US equities were sold off, capital rushed into US Treasuries and the Japanese yen, and the 10-year Treasury yield fell back below 5%. Notably, the 10-year Treasury yield has retreated 40 basis points from its recent peak, a decline that appears particularly unusual given the backdrop of persistently rising oil prices.

ING noted in a report that the market appears to be undergoing a subtle regime shift: higher energy prices no longer mean interest rates will stay elevated forever. Instead, long-end rates are beginning to express more concern about economic growth.

In other words, the market's pricing logic is shifting from inflation panic to growth panic, and a defensive rotation has already begun.

This means dual pressure for the rupee. On one hand, risk aversion itself weighs on risk-sensitive currencies. On the other hand, rising oil prices directly worsen India's terms of trade, and increased hedging demand from importers will further add to US dollar buying.

Oil approaches $115, importer hedging demand heats up

Brent crude has continued to climb after Houthi attacks on Saudi Arabia and is now approaching $115 per barrel. With the world's largest exporter facing the threat of supply disruption, concerns about energy supply have risen rapidly.

For India, every one-dollar increase in oil prices translates directly into a larger import bill and pressure on the current account deficit. The more direct impact comes from the foreign exchange market: importers, especially oil importers, tend to lock in dollar costs in advance when oil prices rise rapidly. Such hedging behavior creates sustained dollar demand in the spot market, amplifying depreciation pressure on the rupee.

The reason the rupee had previously been able to remain relatively stable amid a broadly stronger US dollar largely depended on intervention by India's central bank. The central bank absorbed depreciation pressure by selling dollar reserves, keeping rupee volatility at low levels.

But the current environment is testing the sustainability of that strategy: if risk aversion and rising oil prices persist simultaneously, the central bank will need to consume more reserves to keep the exchange rate stable, and the pace of reserve depletion itself will become a variable the market watches closely.

Foreign capital flows and stock-bond linkage become the next window to watch

Another transmission channel weighing on the rupee comes from capital flows.

Rising risk aversion is often accompanied by foreign capital withdrawing from emerging markets, and the large inflows that India's stock and bond markets previously attracted may face reversal risk. Once foreign outflows accelerate, the rupee will come under dual pressure from both trade and capital channels.

At present, the market has not yet seen a clear signal of large-scale foreign capital withdrawal, but the combination of falling US Treasury yields and equity sell-offs usually means global capital is reallocating risk exposure. For an economy like India's, which has long run a current account deficit and relies on external financing, marginal changes in capital flows are often more noteworthy than the exchange rate itself.

The Reserve Bank of India's previous intervention strategy was built on the assumption that the external environment was broadly controllable. As oil rises from the $80 range to near $115, and as global risk aversion shifts from intermittent fluctuation to a trend-like turn, that assumption is being re-examined.

Whether the rupee can hold its current range ultimately depends on how much reserves the central bank is willing to consume to counter external headwinds, and whether the market believes that willingness can last.