The global bond market cycle has turned hawkish. Central banks globally are on the path of raising interest rates. Most have already initiated the rate-hiking cycle, with clear signals that further hikes may be needed to prevent inflation from choking economies and livelihoods.
Australia began raising rates much earlier, while Japan joined the tightening cycle in June and raised rates again in September, its second hike in six months. The European Central Bank kickstarted its own rate hike cycle in September, closely followed by the US Federal Reserve. In October, the Reserve Bank of India (RBI) hiked interest rates and shifted stance from “neutral” to “calibrated tightening”—its first hawkish shift in close to four years. The shift in central banks’ stance signals a tricky phase for bond funds. Investors must position their fixed-income portfolios carefully to weather the storm.
World turns to rate hikes
Policymakers have turned hawkish to tame inflationary spiral.
*Policy rate after hike
Yet, this global rate hike cycle is notable because central banks are responding to different combinations of energy costs, domestic inflation and economic conditions.
For India, the spillover effects are potentially higher in magnitude. Nishchay Nath, Founder & CEO, BondScanner, observes, “India’s bond market feels global tightening in three ways—higher US Treasury yields, pressure on the rupee, and imported inflation via crude oil.”
Puneet Pal, Head-Fixed Income, PGIM India MF, remarks, “The challenge that we face is one of worsening global/external macros resulting in capital outflows which is pressuring the rupee as interest rate differentials narrow. India, being a current account deficit country, requires forex inflows to preserve financial stability.”
Not surprisingly, the RBI moved in step with other central banks to shield the economy from the inflation spike. India’s central bank raised its benchmark repo rate by 25 basis points to 5.5% this month, while signalling more rate hikes and a hawkish stance.
The central bank was firm in its forward guidance, suggesting that “rate cuts are off the table in the near term” and policy action ahead “can only be a rate hike or a pause”, depending on the evolving conditions and the outlook. The extent and timing of further increases would be contingent on actual inflation and growth data, the RBI further indicated. The domestic inflation outlook and government borrowing remain important independent drivers.
Interest rate tide turns
Current hike cycle in India is starting from a higher base than previous one.
However, unlike earlier hike cycles, experts don’t expect interest rates to go much higher from this point. The starting point of this rate hike cycle is markedly different from the pre vious one. Back in 2022, when global central banks started hiking rates, they were emerging from a prolonged phase of accommodative monetary policy, or lower interest rates. This time, the tightening cycle is taking shape from a higher base than in 2022. Back then, the Indian repo rate stood at 4% at the beginning of the rate hike cycle. The current hike cycle started at a repo rate of 5.25%.
Nath insists, “In 2022, the RBI was raising rates from record lows after the pandemic. This time, the trigger is a spike in energy prices, and the rate gap with the US is much narrower.” If crude oil stabilises and infla tion peaks in the October-December quarter, as projected by the RBI, it could be shorter than the 2022-23 cycle, he adds.
Harsh Gupta Madhusudan, Chief India Strategist, Ionic Asset, remarks, “The rate hike cycle in the US and India is likely to be relatively shallow as of now even though the commentary has gotten hawkish.” Rising global bond yields have already tightened financial conditions, suggesting markets may be overestimating future rate hikes and yields may not rise much further.
Interestingly, the “calibrated tightening” stance was last adopted by the monetary policy committee (MPC) in October 2018, observes CARE Ratings in its report. It was subsequently changed to ‘neutral’ in February 2019, alongside a 25 bps rate cut that marked the beginning of a policy-easing cycle back then. Despite adopting the “calibrated tightening” stance in October 2018, the RBI did not raise rates further. “Given this historical precedent, along with the expected moderation in headline inflation from January-March 2027 onwards, we continue to believe that the current hiking cycle will be shallow,” mentions the report.
Consensus expectations are that the RBI may hike rates by another 50-75 bps in this cycle. We may see further hikes if external imbalances persist. Pal observes, “This interest rate hike cycle is different from the previous ones to the extent that the external macroeconomic variables/backdrop can play a more forceful role in determining domestic monetary policy compared to earlier cycles.” He reckons that in the current backdrop of increasing global cost of capital and geopolitical uncertainty, real rates in India may need to move higher than what would have been otherwise warranted by pure-play domestic growth-inflation dynamics. He expects another 100 bps of rate hikes over the next 6-9 months. This would still make a shallower rate hike cycle than previous ones.
However, many expect the rates to remain elevated for an extended time frame. Pandey reckons yields may remain elevated for longer than markets had anticipated earlier at the beginning of this year. While this does not necessarily imply a sharp rise in yields from current levels, it does point to a more range-bound rate environment, she adds.
Milan Mody, Executive Vice President and Fund Manager, Fixed Income at 360 ONE Asset, asserts, “The direction of policy rates appears increasingly clear, with market participants gradually converging on a higher-for-longer interest rate outlook. The Indian debt market is likely to move sideways under pressure, with a gradual, parallel upward shift in the yield curve.”
Experts maintain that investors should not get adventurous now. Avoid pursuing capital gains from a duration-led portfolio yet. For now, investors will be better served by earning steady income rather than by betting on falling rates, suggests Nath. “They can lock in today’s higher yields in high-quality bonds which will be maturing in one to three years, and ladder them so that money comes back for reinvestment if rates rise further.” The 2021-22 rate hike cycle offers lessons. Long-duration funds returned just 0.61% and 1.83% in 2021 and 2022, while 10-year constant-duration gilt funds delivered 1.76% and 0.75%, respectively. Short duration funds fared better, returning 4.6% and 4.1%.
In the current phase of the cycle, capital preservation remains the first objective, insists Pandey. “The current environment does not call for aggressive duration positioning or excessive credit risk. Instead, it may reward patience, accrual and disciplined portfolio construction.” In an environment where yields remain attractive, there is limited need to move further down the credit curve to enhance returns, she says. High-quality sov ereign, public sector undertaking (PSU) and corporate issuers continue to offer compelling risk-adjusted opportunities. Pal suggests investors can look at short-duration money market funds of up to six months’ maturity, as current yields in that segment are trading at relatively attractive valuations from a risk-reward perspective, given the surplus liquidity. Investors with an investment horizon of more than 12-18 months can look at short duration or corporate bond funds and invest in a staggered manner.
Axis Mutual Fund now favours high-quality corporate bonds in the 1-3 year segment, remains neutral on government securities and cautious on long-duration state development loans (SDLs). It prefers earning accrual income at the shorter end while selectively adding duration as yields rise.
At some point during the rate hike cycle, however, shifting to duration will prove very rewarding. “Longer duration bonds will start to look attractive once inflation peaks, crude oil and the rupee stabilise, and the Fed signals an end to its hikes. Even then, a phased entry is more practical than a single large bet, and the real risk to avoid is reaching for yields at the expense of credit quality,” says Nath. Madhusudan adds investors can gradually increase duration as and when the planned inclusion in Bloomberg Global Aggregate Bond Index is announced and global yields cool.
Australia began raising rates much earlier, while Japan joined the tightening cycle in June and raised rates again in September, its second hike in six months. The European Central Bank kickstarted its own rate hike cycle in September, closely followed by the US Federal Reserve. In October, the Reserve Bank of India (RBI) hiked interest rates and shifted stance from “neutral” to “calibrated tightening”—its first hawkish shift in close to four years. The shift in central banks’ stance signals a tricky phase for bond funds. Investors must position their fixed-income portfolios carefully to weather the storm.
World turns to rate hikes
Policymakers have turned hawkish to tame inflationary spiral.
*Policy rate after hike
Why central banks are wary
Global central banks face a common enemy: inflation. Higher energy prices fuelled by the Iran-US war and sanctions on Russian oil and gas threaten a cost-of-living squeeze worse than the post-Covid spike. With a lasting truce elusive, policymakers expect energy prices to stay elevated. Imported inflation raises recession risks, prompting rate hikes to contain price pressures.Yet, this global rate hike cycle is notable because central banks are responding to different combinations of energy costs, domestic inflation and economic conditions.
For India, the spillover effects are potentially higher in magnitude. Nishchay Nath, Founder & CEO, BondScanner, observes, “India’s bond market feels global tightening in three ways—higher US Treasury yields, pressure on the rupee, and imported inflation via crude oil.”
Puneet Pal, Head-Fixed Income, PGIM India MF, remarks, “The challenge that we face is one of worsening global/external macros resulting in capital outflows which is pressuring the rupee as interest rate differentials narrow. India, being a current account deficit country, requires forex inflows to preserve financial stability.”
Not surprisingly, the RBI moved in step with other central banks to shield the economy from the inflation spike. India’s central bank raised its benchmark repo rate by 25 basis points to 5.5% this month, while signalling more rate hikes and a hawkish stance.
The central bank was firm in its forward guidance, suggesting that “rate cuts are off the table in the near term” and policy action ahead “can only be a rate hike or a pause”, depending on the evolving conditions and the outlook. The extent and timing of further increases would be contingent on actual inflation and growth data, the RBI further indicated. The domestic inflation outlook and government borrowing remain important independent drivers.
Interest rate tide turns
Current hike cycle in India is starting from a higher base than previous one.
Shallow hike cycle
Bond market sentiments have soured since RBI’s shift in stance and tone. Sneha Pandey, Fund Manager–Fixed Income, Quantum Asset Management Company, asserts, “RBI’s 25 bps hike was largely expected, but the shift to calibrated tightening marked the more important policy signal.” Interest rates and bond prices are inversely related. When interest rates rise, bond prices fall and yields rise. The benchmark 10-year bond yield has inched up from 7.2% to 7.4%.However, unlike earlier hike cycles, experts don’t expect interest rates to go much higher from this point. The starting point of this rate hike cycle is markedly different from the pre vious one. Back in 2022, when global central banks started hiking rates, they were emerging from a prolonged phase of accommodative monetary policy, or lower interest rates. This time, the tightening cycle is taking shape from a higher base than in 2022. Back then, the Indian repo rate stood at 4% at the beginning of the rate hike cycle. The current hike cycle started at a repo rate of 5.25%.
Nath insists, “In 2022, the RBI was raising rates from record lows after the pandemic. This time, the trigger is a spike in energy prices, and the rate gap with the US is much narrower.” If crude oil stabilises and infla tion peaks in the October-December quarter, as projected by the RBI, it could be shorter than the 2022-23 cycle, he adds.
Harsh Gupta Madhusudan, Chief India Strategist, Ionic Asset, remarks, “The rate hike cycle in the US and India is likely to be relatively shallow as of now even though the commentary has gotten hawkish.” Rising global bond yields have already tightened financial conditions, suggesting markets may be overestimating future rate hikes and yields may not rise much further.
Interestingly, the “calibrated tightening” stance was last adopted by the monetary policy committee (MPC) in October 2018, observes CARE Ratings in its report. It was subsequently changed to ‘neutral’ in February 2019, alongside a 25 bps rate cut that marked the beginning of a policy-easing cycle back then. Despite adopting the “calibrated tightening” stance in October 2018, the RBI did not raise rates further. “Given this historical precedent, along with the expected moderation in headline inflation from January-March 2027 onwards, we continue to believe that the current hiking cycle will be shallow,” mentions the report.
Consensus expectations are that the RBI may hike rates by another 50-75 bps in this cycle. We may see further hikes if external imbalances persist. Pal observes, “This interest rate hike cycle is different from the previous ones to the extent that the external macroeconomic variables/backdrop can play a more forceful role in determining domestic monetary policy compared to earlier cycles.” He reckons that in the current backdrop of increasing global cost of capital and geopolitical uncertainty, real rates in India may need to move higher than what would have been otherwise warranted by pure-play domestic growth-inflation dynamics. He expects another 100 bps of rate hikes over the next 6-9 months. This would still make a shallower rate hike cycle than previous ones.
However, many expect the rates to remain elevated for an extended time frame. Pandey reckons yields may remain elevated for longer than markets had anticipated earlier at the beginning of this year. While this does not necessarily imply a sharp rise in yields from current levels, it does point to a more range-bound rate environment, she adds.
Milan Mody, Executive Vice President and Fund Manager, Fixed Income at 360 ONE Asset, asserts, “The direction of policy rates appears increasingly clear, with market participants gradually converging on a higher-for-longer interest rate outlook. The Indian debt market is likely to move sideways under pressure, with a gradual, parallel upward shift in the yield curve.”
What to do now
Most fixed income experts recommend a cautious stance, leaning towards shorter maturity bonds and funds. Pandey maintains, “Our preference continues to be for low-to-moderate duration portfolios with a strong focus on accrual.” Accrual refers to the gradual accumulation of interest earned from holding bonds. Meanwhile, a duration strategy emphasises positioning for capital gains before bond prices go up. The latter only happens when interest rates are expected to fall. Rising interest rates spell trouble for longer maturity bonds, which are more sensitive to rate changes. Shorter-duration funds tend to be more resilient.Experts maintain that investors should not get adventurous now. Avoid pursuing capital gains from a duration-led portfolio yet. For now, investors will be better served by earning steady income rather than by betting on falling rates, suggests Nath. “They can lock in today’s higher yields in high-quality bonds which will be maturing in one to three years, and ladder them so that money comes back for reinvestment if rates rise further.” The 2021-22 rate hike cycle offers lessons. Long-duration funds returned just 0.61% and 1.83% in 2021 and 2022, while 10-year constant-duration gilt funds delivered 1.76% and 0.75%, respectively. Short duration funds fared better, returning 4.6% and 4.1%.
In the current phase of the cycle, capital preservation remains the first objective, insists Pandey. “The current environment does not call for aggressive duration positioning or excessive credit risk. Instead, it may reward patience, accrual and disciplined portfolio construction.” In an environment where yields remain attractive, there is limited need to move further down the credit curve to enhance returns, she says. High-quality sov ereign, public sector undertaking (PSU) and corporate issuers continue to offer compelling risk-adjusted opportunities. Pal suggests investors can look at short-duration money market funds of up to six months’ maturity, as current yields in that segment are trading at relatively attractive valuations from a risk-reward perspective, given the surplus liquidity. Investors with an investment horizon of more than 12-18 months can look at short duration or corporate bond funds and invest in a staggered manner.
Axis Mutual Fund now favours high-quality corporate bonds in the 1-3 year segment, remains neutral on government securities and cautious on long-duration state development loans (SDLs). It prefers earning accrual income at the shorter end while selectively adding duration as yields rise.
At some point during the rate hike cycle, however, shifting to duration will prove very rewarding. “Longer duration bonds will start to look attractive once inflation peaks, crude oil and the rupee stabilise, and the Fed signals an end to its hikes. Even then, a phased entry is more practical than a single large bet, and the real risk to avoid is reaching for yields at the expense of credit quality,” says Nath. Madhusudan adds investors can gradually increase duration as and when the planned inclusion in Bloomberg Global Aggregate Bond Index is announced and global yields cool.
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