Is moderation ahead for India’s 10-year bond yield? What should investors do?

India's 10-year bond yield: Indian government benchmark bond yields rose significantly by 2 per cent in the previous session on Thursday, August 8, to the level of 6.9 per cent after the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained a status quo on policy rates and stance and retained its overall growth and inflation target for the current financial year (FY25).

The benchmark 10-year yield is witnessing gains in August. After a drop of over 1 per cent last month, the yields on the benchmark government bonds are up by about 1 per cent this month so far. Year-to-date, they are down about 2.6 per cent.

Since bond yields and prices move inversely, a rise in bond yields typically means that bond prices are falling. This could be due to higher interest rates or a decrease in bond demand.

Moderation ahead?

Bond yields tend to rise during times of elevated interest rates. However, with expectations high that the US Fed and RBI will embark on a rate reduction cycle in the coming policy meetings this year, experts believe bond yields could see some moderation.

"The short-term bond market outlook is optimistic, driven by anticipated rate cuts from central banks in India and the US. The RBI may lower the repo rate from 6.5 per cent in the recent quarter, which is likely to boost bond prices, particularly for high-quality fixed-income bonds of intermediate duration (3-5 years)," said Anshul Jain, the head of research at Lakshmishree Investment & Securities.

Jain observed that the Federal Reserve is also expected to reduce rates in the US, as the unemployment rate rose to 4.3 per cent in July 2024, signalling economic challenges that may prompt supportive rate cuts.

A lot about the Indian bonds will depend on the RBI's policy move in October.

Vishal Goenka, the co-founder of IndiaBonds.com, underscored that while it looks pretty certain that the US Fed will cut rates in its September meeting, it may not necessarily transform into immediate cuts by RBI as insulation means we have domestic factors such as inflation and growth that play an important factor.

"The ‘wealth effect’ created by high equity valuations fuels inflationary pressures. The credit-deposit ratio imbalance in the banking system would further edge up market rates for capital and deposits," Goenka said.

What should investors do?

Considering these conditions, Jain believes focusing on intermediate-duration bonds can be beneficial, offering a balance between yield and risk. Moreover, investors may also consider high-quality corporate bonds for their higher yields and strong fundamentals.

"Maintaining a diversified bond portfolio is essential to effectively managing risks and capturing opportunities across the bond market. This approach helps spread risk and enhances the potential for stable returns in a fluctuating economic environment," Jain said.

Goenka finds the outlook for Indian bonds constructive, with the potential to benefit from the cyclical downmove in the next couple of years. 

"The best way to express this would likely be a barbell strategy where potential for capital gains are picked up from long-term government and bank infrastructure bonds. The benefit from a current high level of interest rates can be derived from short-term high-yield bonds after investors’ due diligence on corporates," said Goenka.

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