India’s favored investment in five-year government bonds is losing its shine, say fund managers. The bond market has already factored in expected interest rate cuts, reducing the appeal of this strategy.
The 6.75% bond maturing in 2029 has seen heavy buying since March. This demand pushed its yield down by 80 basis points, one of the largest drops among government bonds.
The yield now trades 15 basis points below the Reserve Bank of India’s (RBI) policy repo rate of 6%, marking the deepest inversion in 11 years.
Murthy Nagarajan, head of fixed income at Tata Asset Management, said the yield falling well below the repo rate is due to several reasons but believes the drop has gone too far.
The RBI is expected to cut rates by at least 50 basis points in the coming months. However, Laukik Bagwe, fund manager at ITI Mutual Fund, noted that the five-year bond has already priced in most of these expected cuts. He added that further gains may be limited unless the RBI signals more easing.
Despite this, foreign investors like Nomura, Standard Chartered Bank, and BofA Securities still recommend investing in shorter-duration bonds, including the five-year segment. They believe liquidity support from the RBI will benefit these bonds.
The 2029 bond remains among the top five most traded securities in recent months. But fund managers now expect more focus on 10-year government bonds.
Dhawal Dalal, president and CIO of fixed income at Edelweiss Asset Management, predicts the 10-year bond yield will move toward 6% in the medium term. He expects the repo rate to settle between 5.25% and 5.50%.
Nagarajan also forecasts the 10-year bond to outperform, with yields falling to around 6.10%. Since March, the 10-year yield has dropped by 39 basis points, widening its gap over the five-year yield to 35 basis points—the largest spread in three years.
