After Sept, bond yields to peak in Oct too? Experts decode future of Indian bond market; RBI's next move holds key

India’s bond market is entering October with the comfort of strong domestic growth but the discomfort of rising inflationary pressures, elevated global yields and tighter liquidity conditions.

The sharp rise in the domestic 10-year benchmark yield in September has changed the complexion of the fixed-income market, with investors now having to navigate a combination of geopolitical uncertainty, oil prices, central-bank policy and potential additional supply.

The domestic 10-year yield rose around 30 basis points in September to approximately 7.20%, following an 11-basis-point increase in August. It was 6.6% at the start of the year. The move tracked the global bond market, with the US 10-year Treasury yield rising around 53 basis points to 5.22%.

Milan Mody, Executive Vice President and Fund Manager, Fixed Income at 360 ONE Asset, said the September environment was shaped by persistent US-Iran tensions, higher crude prices and tighter global monetary policy.

“Tensions between the US and Iran continued to simmer through September, keeping oil prices firmly above US$100 per barrel. As inflationary risks intensified, global central banks tightened policy, with the US Federal Reserve, the European Central Bank and the Bank of Japan each raising policy rates,” Mody said.

Will bond yields stay elevated in October?

Indian bond yields are likely to remain under pressure as the Reserve Bank of India works to absorb surplus liquidity while market participants track borrowing needs, inflation and global bond yields.

Mody expects the Indian debt market to remain under pressure, with the yield curve potentially shifting gradually higher in parallel. The monsoon season ended with a deficit of around 15%, while elevated oil prices and global bond yields could add to pressure on domestic yields.

“The direction of policy rates appears increasingly clear, with market participants gradually converging on a higher-for-longer interest rate outlook. In our view, the Indian debt market is likely to move sideways under pressure, with a gradual, parallel upward shift,” Mody said.

At the same time, he believes yields are moving towards a more reasonable valuation zone. The market, however, is already factoring in a 75-basis-point rate hike and a gradual increase in inflation.

The eventual inclusion of fully accessible route securities in the Bloomberg index could provide support to Indian bonds.

Foreign portfolio investors have remained a source of support, with net purchases during the year so far standing at US$5.5 billion.

The direction of yields in October could depend heavily on developments in the US-Iran conflict and movements in bond yields in Japan and the US.

Domestically, the RBI’s communication on inflation and its approach towards surplus liquidity at the upcoming Monetary Policy Committee meeting could become important triggers.

What should investors do?

For the medium to long term, Mody expects the 10-year benchmark to remain within a defined range, although geopolitical risks could keep yields elevated in the near term.

“In our view, the absence of a resolution to the West Asia conflict is likely to keep domestic yields elevated in the near term, and we expect the 10-year benchmark to trade between 7.05% and 7.20%,” Mody said.

For fixed-income portfolios, 360 ONE Asset remains neutral on duration and prefers greater exposure to short- to medium-maturity corporate bonds. Mody said the risk from higher yields appeared more pronounced in ultra-long maturities, while credit quality remained strong.

Shorter-tenure corporate bonds, therefore, could offer a better risk-reward trade-off in the current environment, while dynamic bond funds may suit investors seeking flexibility across credit and duration, depending on their risk profile and investment horizon.

Will RBI hike repo rate?

Mody believes the RBI’s monetary policy is at an inflection point, with higher food prices linked to El Niño conditions and rising oil prices adding upside risks to inflation. Against this backdrop, liquidity management could become increasingly important for the central bank.

He expects the repo rate to rise by 50 to 75 basis points by next year, describing the move as a recalibration aimed at bringing rates closer to neutral levels while supporting the currency. Forex management is expected to remain another key area for investors to monitor.

He also expects the RBI to rely on a combination of OMO sales and sell-buy swaps to manage surplus liquidity. His estimates point towards OMO sales of around ₹2 trillion and US$35 billion, equivalent to approximately ₹3.3 trillion, through FX maturity or sell-buy swaps.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.