What should debt market investors do amid cooling bond yields?

Estimated read time 13 min read

Indian government bond yields have softened and the yield on the benchmark 10-year note is trading around 6.99%, below the psychological 7% mark. Local fundamentals remain strong, while hopes of interest rate cut in the US also led to bond yields drifting lower.

Domestic bond yields cooled off in the month of May after the Reserve Bank of India (RBI) declared a dividend of 2.1 lakh crore, almost double the amount which bond markets expected.

While the higher dividend provides larger flexibility to the central government on the fiscal side, the positive surprise enthused the markets, with the benchmark 10 year bond yield ending the month at 6.98%.

Also Read: Expert view: Indian stock market not in a bubble, still below the long-term trendline, says Devina Mehra of First Global

Meanwhile, India’s headline retail inflation fell to a 12-month low of 4.75% in May. 

Domestic GDP growth for FY24 rose to 8.2% YoY from 7.0% in FY23, while GVA growth rose to 7.2% versus 6.7% in FY2023. Trade deficit widened to a seven-month high of $23.78 billion in May, government data showed.

“Strong GDP growth rate, stable inflation and external position underscore the current strong macroeconomic position of India providing a tailwind for markets. INR was stable during May, ending the month at 83.47. FPI inflows into the bond markets turned positive with $1.05 billion of inflows after the negative number in the month of April. On a CYTD basis, FPI flows into debt remain positive at $6.76 billion,” said Puneet Pal, Head- Fixed Income, PGIM India Mutual Fund.

Also Read: India Inc’s revenue growth estimated to slow down QoQ, operating margins to remain steady at 15-18% in Q1FY25: ICRA

The yield curve remained flat as demand-supply dynamics are favourable. The Overnight Index Swap (OIS) curve echoed the bond curve and went lower during the month. The 1 year OIS was down 3 bps ending the month at 6.85%, while the 5 year OIS was down by 16 bps during May, ending the month at 6.44%. The 1 year OIS is not pricing in any rate cuts over the course of the year, Pal added.

Global bond yields also cooled off with the benchmark US 10-year bond yield down by 18 bps on the back of relatively softer economic data.

Also Read: Fitch raises India’s growth forecast for FY25 to 7.2% from 7%

“Going ahead we believe that RBI is likely to be on a long pause and is likely to start cutting rates only after the developed market central banks start their rate cutting cycle. Given the current growth – inflation dynamics in India, we believe rate cuts will start from Q4-FY2025 onwards,” Pal said.

Markets tend to react before the start of a rate cutting cycle, and any retracement in yields offers a good opportunity to investors to increase their allocation to fixed income, as real and nominal yields remain attractive with favourable demand-supply dynamics playing out in the sovereign bond market, he added.

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Published: 18 Jun 2024, 12:33 PM IST

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