Quote on Monthly Debt Market Outlook by Puneet Pal of PGIM India Mutual Fund
Below the Quote on Monthly Debt Market Outlook by Puneet Pal of PGIM India Mutual Fund
High bond yields and rupee weakness in spotlight
Bond yields continued their upward trajectory in December 2025 in spite of a dovish MPC policy earlier in the month, as bond markets continue to grapple with adverse demand/supply dynamics. A dovish Monetary Policy Committee (MPC) stance at the start of the month failed to enthuse the bond markets even as The Reserve Bank of India (RBI) announced Rs 1 trn of Open Market Operations (OMO) purchases and $5 bn of USD-INR swap to ease liquidity.
Yields rose across the curve, though the longer end of the curve was spared as value buying kicked in. The benchmark 10yr Bond yield rose 8 bps from the start of the month, ending the month at a yield of 6.59%, after rising to a high of 6.67%. INR volatility dampened sentiments in the bond market before the bond markets got a breather as RBI announced incremental OMOs of Rs 2 trn coupled with a $ 10bn USD/INR swap. Yields moderated after the announcement.
The RBI also started intervening in FX markets to smoothen INR volatility as INR become the focus of the markets as it depreciated sharply to touch an all-time low against the USD at 91.03 before closing the month at 89.88. Even after the announcement of OMOs and USD/INR buy-sell swaps, the bond markets remain quite cautious. The perceived end of the rate cutting cycle and the continuous lingering adverse demand/supply situation has led to yields trending higher over the last 5 months. The 10yr bond yield has fallen by just 20bps this calendar year while the 40yr yield has risen by 25bps in spite of 125 bps of policy rate cuts and over Rs 6 trn of OMO purchases by RBI in this calendar year. The Credit Reserve Ratio (CRR) has also been cut by 100bps and despite such liquidity easing measures, the durable liquidity in the banking system has fallen from its high of Rs 5.84 trn in May 2025 to the current durable liquidity surplus of Rs 2.60 trn as of November 2025.
Earlier in the month, Consumer Price Index (CPI) Inflation came in at 0.71% which was in line with expectations. “Core” CPI Inflation was steady at 4.4% though excluding gold etc., the “core core” inflation softened to 2.40%. Though CPI Inflation seems to have bottomed, it is still expected to remain in the vicinity of 4.00% in FY27 thus enabling the RBI to be on an elongated pause. Trade deficit for the month of November narrowed and came in at $24.50 bn down from an all-time high of $42 bn reported in October. A sharp fall in Gold imports by $11 bn helped moderate the trade deficit. Non-oil exports also grew (20% YoY). Current Account Deficit for FY 26 is expected to come in around 1.20%, almost double of FY25 which was at 0.60%, though it remains pretty much manageable.
The central bank’s intervention in the FX markets picked up as INR breached the 91 handle against USD. The approach of RBI seems to allow for calibrated INR depreciation. The RBI’s outstanding position in USD forwards is estimated to be around $66 bn as of November. Foreign Portfolio Investors (FPIs) sold Indian debt for the first time since June as they have sold $1.66 bn from debt in the month. Outflows from equity continued with $2.17 bn of FPI outflows during the month. On a CYTD basis, FPI inflows into debt stand at $6.33 bn, while equity saw FPIs pulling out $18.74 bn. There is some optimism regarding Indian Fully Accessible Route (FAR) government bonds getting included in the Bloomberg global aggregate bond index, which can lead to FPI inflows next year.
The Overnight Index Swap (OIS) curve saw bear steepening with the 5yr OIS yield going up by 16 bps while the 1yr OIS yield remained flat. Money market liquidity remained in deficit, though the RBI has been managing liquidity proactively through Voluntary Retention Routes (VRRs). Three-month maturity Certificate of Deposit (CD) yields closed the month around 5.95%-6.00% after trading at a high of 6.15% and 1yr maturity CDs were trading around 6.60% at the end of the month after touching a high of 6.70%.
Bond yields have remained elevated across developed markets and the benchmark US 10yr bond yield continues to stay above 4% even after the US Fed reduced policy rates. Japanese bond yields continue to rise fuelling some concerns around the unwinding of “carry trades”, though there is no major dislocation in the global markets so far.
There seems to be a lack of appetite for bonds in the Indian market despite a dovish RBI and persistent OMOs. On a CYTD basis, the RBI has done almost Rs 6.50 trn of OMOs with an additional Rs 1.50 trn to be done in January 2026. We believe that bond yields can find support at current levels and expect the 10yr benchmark yield to trade in a range of 6.40% to 6.75% over the next couple of months. Bond markets will be keenly watching the supply of SGS (state government securities) for the next quarter. The Market is expecting Rs 4.5 trn - 4.75 trn of SGS supply next quarter and any meaningful reduction will be supportive of bonds.
Investors can continue to allocate to Corporate Bond Funds having portfolio maturity up to 3yrs while being tactical in their allocation to duration through Dynamic Bond Funds. Investors should have a minimum investment horizon of 12-18 months while investing. Money market yields of up to 1yr are also looking relatively attractive from a risk-reward perspective. Investors with short-term investing horizon can look to allocate in this segment also. We expect a long pause on policy rates and accrual to be the major factor in overall fixed income returns next year.
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