Indian government bonds experienced significant pressure on Thursday, with the benchmark 10-year yield hitting a two-year high of 7.21%, reaching its highest level in two and a half years and marking the worst week in seven years with nearly 10 basis points gained this week. As reported by The Economic Times, the decline was driven by surging global yields with the US 10-year Treasury yield inching up to 5.33%, a two-decade high, while Brent crude futures climbed back above $100 adding to market pressures. The spread between the Indian benchmark and US 10-year yield reached the tightest in more than a year, with the debt market shut Friday for a local holiday compounding supply-side challenges. Despite the weakness, Indian bonds still outperformed global peers as strong government finances and ample banking system liquidity provided support. According to The Hindu BusinessLine, Venkatakrishnan Srinivasan, Managing Partner at Rockfort Fincap LLP, noted that "Bond markets have absorbed the global rise in yields, uncertainties arising from the West Asia crisis and soaring oil prices. Current yield levels are unlikely to move below 7.2 per cent unless the crisis in West Asia subsides and crude oil prices fall below $80 a barrel and remain there."
Market expectations for monetary policy tightening have intensified significantly, with India's overnight indexed swaps surging as the one-year rate rose 6.75 basis points to 6.2650%, two-year rate jumped 7.5 basis points to 6.48%, and the 5-year added 8.25 basis points to 6.73%. According to The Hindu BusinessLine, markets have largely priced in a 25 basis point rate hike by the Reserve Bank of India at the upcoming Monetary Policy Committee meeting scheduled for October 7, 2026, to tackle elevated retail inflation stemming from a 13 per cent rainfall deficit. Barclays and BofA Global Research have advanced their first hike calls to October from December, while 60% of economists in a Reuters poll expect a 25-basis-point increase. Sreejith Balasubramanian, senior economist at Bandhan Mutual Fund, noted that "RBI may have to considerably tighten monetary policy in the months ahead, with next week's meeting being live, and deploy measures to absorb excess liquidity." Traders have scrambled to reverse expectations for US interest rate cuts this year, with them now expecting at least three more Federal Reserve hikes before the middle of 2027. With oil prices continuing to soar and an anticipated rate hike, analysts predict these yields could escalate to 7.50% levels if the Reserve Bank of India enacts a 25 basis point increase.
Fixed income is gaining renewed attention among Indian investors as rising yields and strong corporate credit create a more favourable entry point, according to fund managers speaking at the Morningstar Investment Conference 2026. Sunaina Da Cunha, Co-CIO (Debt) at Aditya Birla Sun Life AMC, currently favours liquid and short-duration funds, shifting to 2–3 year corporate bonds once volatility eases. She noted that corporate bond spreads up to five years look attractive, and that companies entered this cycle having deleveraged and strengthened balance sheets during the previous rate cycle. Devang Shah, Head of Fixed Income at Axis Mutual Fund, advised adding duration once the first rate hikes are in, unless the cycle turns deeper than expected. Manish Banthia, CIO of Fixed Income at ICICI Prudential AMC, flagged a global rotation from equities into bonds but pointed to India's shallow corporate bond market as a structural concern, citing inefficient taxation that keeps retail investors away from non-AAA paper. All three managers cautioned against market timing, stressing that matching the investment horizon to fund duration and maintaining the right asset allocation matter more than timing the market.
A concerning trend has emerged in the retail bond market where only 3% of bonds on major platforms are AAA-rated, while nearly 66% are rated A+ or below, according to recent market analysis. As reported by Mint, 68% of BBB bonds can be purchased for ₹10,000 or less, compared to just 17% of AAA bonds, creating a significant risk profile for retail investors. IDFC First Bank expects demand for government securities to fall significantly short of supply in the second half of this fiscal year, as the government borrowing calendar coincides with the RBI's likely sale of another ₹1 lakh crore of government securities through open market operations (OMO) sales. This credit inversion occurs because institutional money sticks to AAA paper while retail investors are being funneled into lower-rated debt, with smaller issuers needing retail money and issuing in small denominations. New Delhi raised the issuance of long-term bonds in its borrowing plan for the second half of the fiscal year and the central bank sold the most bonds through open market operations in a decade to narrow a record cash surplus. Traders are bracing for a deluge of state government debt, with the market expecting ₹3.25-3.5 trillion of bond issues between October-December. The government sold debt of ₹33,000 crore on Thursday, while state governments are expected to sell bonds worth ₹3.3 lakh crore to ₹3.5 lakh crore next week, potentially weakening supply-demand dynamics with supply outweighing demand.
For retail investors, experts suggest a barbell approach for long-term investors - core allocation in government securities or target maturity funds for sovereign exposure, incremental allocation in AAA-rated corporate bonds for additional yield pickup, and tactical allocation in longer-duration instruments only when yields move materially higher. As reported by ETMarkets, investors with 3-5 year horizons can benefit from locking in sovereign yields near current levels, while short-term investors face more balanced risk-reward profiles due to potential yield volatility from US Treasury movements, crude price fluctuations, and inflation expectations. Prashant Pimple, Chief Investment Officer at Baroda BNP Mutual Fund, adopts a bearish duration stance citing strong domestic growth, inflation risks, persistent surplus liquidity and the RBI's shift to OMO sales. A private-bank trader noted that "OMO sales is a hanging sword, which will continue to keep pressure on yields," highlighting ongoing concerns about excess liquidity absorption measures. Pass-through certificates remain a safer alternative, offering backing from thousands of borrowers and a ₹110-₹125 cushion of loans and cash per ₹100 invested, though regulatory barriers limit access to institutional investors with minimum investment requirements of ₹1 crore.
