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The current stance of RBI is to support growth and it has taken a proactive approach towards liquidity management. Bond markets are expecting deeper rate cuts of 50-100 bps over the next two quarters  after the change in monetary policy stance to “accommodative” and expectation of inflation coming in 40-50bps below the average forecast of 4% in FY26. Demand supply dynamics remain favourable in the bond markets with RBI conducting OMOs. We expect 50bps rate cut from RBI with only a material slowdown in growth below 6% leading to the policy rate falling below 5.50%.

Investors can continue to allocate to Short Term/Corporate Bond Funds having portfolio duration up to 4yrs while being tactical in their allocation to Dynamic Bond Funds. Investors should have an investment horizon of 12-18 months while investing. Money market yields of up to 1yr are looking attractive from a relative risk-reward scenario and investors can look to allocate in that segment also. We expect the 10yr bond yield to trade in a range of 6.00% to 6.40% over the course of the next one quarter.

Indian Markets:

Yields continued to drift lower during the week though there was some profit booking below 6.23% on the 10yr bond. The benchmark 10yr bond yield ended the week at 6.25%, down 2bps over the week. The new 10yr bond was down 1bps ending the week at 6.21%. There was some profit booking during the week below 6.20% yield. Overall, the curve remained steep with the longer duration bonds underperforming shorter duration bonds. 

The spread between the 10yr and the 40yr bond yields increased to 62bps from 59 bps last week, when compared with the new 10yr bond yield. This spread was 45bps at the start of the month. The shorter end of the yield curve (1-5yrs) has outperformed the rest of the curve. The 5yr yields came down by 8 bps during the week and have come down by 20 bps in the month of May. The 5yr bond yield is trading below the policy repo rate, for the first time since demonetisation when the banking system was flush with deposits and liquidity.  

The steepness in the yield curve has been due to the surplus liquidity in the system and the growing expectations of a deeper rate cutting cycle which have been reinforced by lower inflation. CPI inflation is expected to remain well below 4% till the end of CY2025. The much anticipated announcement of the RBI dividend happened on the last day of the week with RBI declaring Rs. 2.69 lac cr. higher than the budgeted amount of Rs. 2.10 lac cr. but  lower than the market expectations of higher than Rs. 3 lac cr. The Central Board of RBI changed the Economic Capital Framework (ECF), widening the Contingency Risk Buffer (CRB) range to 4.5%-7.50% of the RBI’s balance sheet from 5.50%-6.50% earlier. Buoyed by higher dollar sales, RBI potentially could have declared a higher dividend but adopted a prudent and conservative approach and kept the CRB at 7.50% this year.

The lower than expected dividend can lead to upward pressure on the very short end (1-6 months) of the money market curve, where yields have fallen steeply over the course of the last fortnight. In a data light week, the newly introduced monthly labour market data, released last week, shows the labour force participation rate in India was 55.60% in April while the unemployment rate was 5.10% though the youth unemployment rate was high at 13.8%. 

The release of this data is important and the trends observed from this data can help in a better understanding of the growth employment dynamics.  As a result of RBI’s proactive stance on infusing liquidity, the durable liquidity is estimated to be close to Rs. 4 lac cr., which is the highest in over 6 months and is expected to increase further with the declaration of RBI’s dividend, potentially taking the durable liquidity closer to Rs. 6.5 lac cr. This surplus liquidity has led to curve steepening with the overnight lending rates averaging below the SDF rate. FPI selling in debt continues with almost USD 1bn of outflows in May.

The OIS curve also steepened with the 1yr OIS yield lower by 8 lower during the week ending the week at 5.54% while the 5yr OIS yield was down 1bps, ending the week at 5.63%.  

INR strengthened marginally to 85.22 from 85.52 on DXY weakness as DXY ended the week at 99.11 down from last week’s closing of 101.09. 

We will have the Q12025 GDP on May 30th and the market expectations are at 6.70% compared to 6.2% in Q4 2024. 

International  Markets:

Globally, bond yields stayed stable but elevated as fiscal concerns linger on. Reserve Bank of Australia  reduced rates as expected and sounded dovish with market expecting another rate cut by August. The PBOC also announced a reduction in its 1yr and 5yr Prime Loan Rate (LPR) by 10 bps each following up on its earlier rate cuts in order to shore up the faltering economy.  Most of the headlines over the week were reserved for long end (20-40yrs) Japanese yields as yields rose flagging concerns on fiscal sustainability. The longer end (20-40yrs) Japanese bond yields have risen 85 bps since the beginning of 2025 to their highest levels in 25yrs. US benchmark 10yr bond yield ended the week at 4.51%, 3 bps higher during the week but the longer end on the curve sustained above 5% on fiscal concerns. The longer end of the curve will be the space to watch out for in the coming weeks and months as bond markets awaken to the reality of fiscal challenges while governments and central banks look to keep yields under control.