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Our View:

The Inflation projections for FY27 hold the key for bond markets along with any measures by RBI to address the current adverse demand  supply dynamics in the upcoming 1st October MPC policy meeting. Inflation is likely to undershoot RBI’s projections for FY26 and we  continue to expect one more policy repo rate cut.

We believe that the SGS curve and AAA corporate bond curve of 4-6yrs maturity segment presents a decent investment opportunity in  the current circumstances. The longer end of the curve (30yr) also presents a short term tactical opportunity as yields at the longer end  are unchanged over the last one year and also from the beginning of the CY25 which can result in value buying.  

Investors can continue to allocate to Corporate Bond Funds having portfolio maturity up to 5yrs while being tactical in their allocation  to duration through Dynamic Bond Funds. Investors should have an investment horizon of 12-18 months while investing. Money market  yields of up to 1yr are also looking attractive from a relative risk-reward scenario for investors with short term investing horizon and  investors can look to allocate in that segment also. We expect the 10yr bond yield to trade in a range of 6.40% to 6.70% over the course  of the next one month.

Indian Markets:

Bond yields have been stable this month relative to the sell off witnessed over the last couple of months. Yields stabilised as attractive  valuations led to some value buying helped along the way with some constructive comments from the Finance ministry. The Reserve  Bank of India (RBI) also, informally, checked with market participant the reasons for the rise in yields. This and attractive valuation led  to value buying with the longer end yields coming down by 12 bps while the benchmark 10yr yield is down by 4 bps.  

The relative movement of the G-sec and the OIS curve indicates that the rise in yields have more to do with adverse demand supply  dynamics with the higher State government securities (SGS) supply putting more pressure at the longer end of the curve. The traditional  demand from long only real money investors like insurance and pension funds have been lacklustre this year and this trend is likely to  continue. Bond market participants had given feedback to RBI to reduce the supply at the longer end of the curve and RBI accepted  that demand as it reduced the supply of longer maturity securities in the borrowing calendar announced for H2.  

In the borrowing calendar announced for H2, RBI has reduced the supply of longer tenure securities (15yrs and above maturity) by 8%  while increasing the supply of up to 10yrs maturity by 8%. The 10yr point of the curve is the most liquid and the supply there has been  increased to 28% from 24%. While reducing the supply at the longer end of the curve can help the yields at the longer end marginally,  persistence of the adverse demand supply dynamics will continue given the elevated SGS supply.  

There is a section of the market which is expecting RBI to conduct OMOs to take care of the supply overhang but we believe such intervention may not be forthcoming immediately given the current structural liquidity surplus and OMO purchases by RBI have a higher  probability in the last quarter of this financial year.  

The fear in the bond markets regarding the cut/rationalisation of GST gave way to relief as the contours of the GST rationalisation  become clear with an estimated fiscal impact of around INR 30,000 crore for the remainder of this fiscal. From a structural perspective,  it can boost growth while lowering headline inflation. Thus, it’s a positive from a structural perspective. CPI inflation came in line with  market expectations at 2.07%, led again by food inflation, coming in flat on a YoY basis while “Core” inflation came in at 4.20%. The  impact on inflation from the GST rate cuts is favourable and is estimated to be in the vicinity of 0.6% -0.8% though one has to wait  and see the actual passthrough impact. Arguably, the impact on core inflation should be higher. This has led to analysts expecting the  FY26 inflation to average around 2.50% compared to RBI’s estimate of 3.10%. Notwithstanding the expectations of lower inflation in  this fiscal, the key for the bond markets remains the RBI’s estimate of inflation for FY27. At the start of the month, the Q1 CAD came  in at 0.2% of GDP (lowest Q1 deficit since 2017) reflecting strong GCC services export.

FPI outflows continued from equity with almost USD 2.25bn outflows, though in contrast debt received inflows to the extent of USD  830mn. CYTD 2025 FPI inflows have been USD 5.60 bn in debt while the equity markets had outflows to the tune of USD 18.79 bn.  The OIS curve has come down with a steepening bias this month with the 1 year OIS coming down by 6 bps to 5.46% while the 5 year  OIS coming down by 4 bps to 5.74%. Money market yields have hardened on back of tight liquidity after the GST and advance tax  outflows. 3 month maturity CD’s are trading around 5.90% while 1yr maturity CD’s are trading 6.40%.  

Monsoons remained surplus and till date, cumulative rainfall was 7% above long-term average.  

International Markets:

The US Fed reduced policy rates by 25 bps on back of weakness in the labour markets though long end bond yields did not react much.  Globally, bond yields remained elevated, especially at the longer end given the fiscal/debt concerns in UK and France. The BOJ held  rates in a split decision though it surprised markets with a proposal for ETF sales of JPY 620 bn annually.