10-Year Government Bond Yield Has Spiked. Here's Why

The change in stance provided flexibility to the MPC as regards policy rates.

A couple of days later, on October 14, 2024, the Ministry of Statistics & Programme Implementation (MOSPI) released the Consumer Price Index (CPI) inflation data for September 2024, which touched a 10-month high of 5.49%. This was mainly on account of all India Consumer Food Price Index (CFPI) inflation at 9.24% (provisional). It is important to note that food & beverages have a weight of 46% in the headline inflation.

Fuel & Light inflation remained almost flat in September 2024 compared to the previous month but compared to September 2023 reported a slightly lower reading.

Thus, core inflation -- which excludes food and fuel -- also rose to an 8-month high of 3.65% in September 2024 versus 3.60% in the previous month.

Higher headline CPI inflation dashed the expectations of a rate cut by the RBI in the December 2024 bi-monthly monetary policy, particularly as food inflation is not expected to ease very soon.

In the latest RBI Bulletin released in October 2024, it is observed that the recent uptick in food and metal prices, as seen in the Food and Agricultural Organisation (FAO) and the World Bank price, if sustained, can add upside risk to inflation. Similarly, unexpected weather events and the worsening of geopolitical conflicts constitute major upside risks to inflation.

RBI Governor, Mr. Shaktikanta Das has cautioned that policy interest rate cuts at this moment could be "very premature" and "risky". Watch this video to know what’s upsetting the Indian bond market:

This is in contrast to several other economies, who abetted by disinflation have resorted to rate cuts of late.

Among the major and advanced economies, the U.S. Federal Reserve cut its target range by 50 basis points (bps) to 4.75-5.0% in September 2024, marking its first cut in four years.

Going forward, Federal Reserve policymakers support rate cuts in the ensuing meeting on November 6-7, 2024, as inflation is already on the path to the 2% inflation target.

Recently, the ECB also reduced interest rates by 25 bps based on the updated assessment of the inflation outlook, dynamics of underlying inflation, and strength of monetary policy transmission. This is the third rate cut this calendar year 2024 by the ECB to support the economy.

Among EME central banks, Thailand and the Philippines cut their policy rates by 25 bps in October 2024. China too announced a series of stimulus measures to resurrect its flagging economy (including a 20 bps cut in the seven-day reverse repo rate, a 30 bps reduction in the medium-term lending facility rate and a 50 bps cut in the reserve requirement ratio).

The Indian Bond Market Seems Upset

Given persistent headline CPI and CFPI inflation and the disinclination of the RBI to cut policy rates in a hurry (considering the risks to the inflation trajectory), seems to be upsetting the Indian bond market.

The 10-yr benchmark G-sec yield since the October 2024 bi-monthly monetary policy statement has so spiked by a noticeable 18 basis points (bps) as of October 21, 2024.

The fact also is the rise in the 10-year U.S. Treasury yield is causing the spike in the government of India's 10-year G-Sec yield. This is because market expectations of the Federal Reserve rate cut for November shifted to 25 bps (after an aggressive 50 bps rate cut in mid-September 2024) and as stronger than expected job market data pared expectations of a bigger rate cut.

So, there is a mix of factors, domestic and global, that are influencing India's benchmark yield.

Having said that, the average term spread (10-yr G-sec yield minus 91-day Treasury Bill yield) does not seem remarkable, in fact is quite stable at around 50 bps. Whereas the spread between the 10-yr U.S. Treasury yield is 277 bps.

Moreover, as per the RBI, the volatility of yields in the Indian bond market has been low compared to that of the U.S. treasury market, though both have risen since August 2024.

The prudent monetary policy actions and stance taken by the RBI have been able to align inflation within the target thus far and keep away abnormal spikes in the Indian 10-year G-sec yield.

Path to Interest Rates

Well, the path to interest rates is hinged on the path to inflation trajectory. The six-member MPC in the last bi-monthly monetary policy meeting has reiterated that that enduring price stability strengthens the foundations of a sustained period of high growth.

After a transient spike in the near term, the MPC expects headline CPI inflation to moderate. The change in stance to 'neutral' provides flexibility to the MPC while enabling it to monitor the progress on disinflation which is still incomplete.

However, in the near term, the MPC is seeing risk stemming from:

• Uncertainties relating to heightened global geo-political risks

• Financial market volatility

• Adverse weather events, and

• The recent uptick in global food and metal prices 

Hence, the MPC is remaining vigilant of the evolving inflation outlook.

The MPC is resolute in its commitment to aligning inflation to the 4.00% target within a band of +/- 2% on a durable basis while supporting growth.

That being said, it appears that we are almost near the peak of the interest rate upcycle.

Investment Strategy to Follow When Approaching Debt Mutual Funds Now

At the current juncture, it would be an opportune time to invest in longer-duration debt mutual funds with a medium-term view of 3 to 5 years whereby you benefit from higher yield and unlock the capital growth. However, it is best to invest in these funds in a staggered manner.

If you have a shorter investment horizon, consider investing in the shorter maturity debt funds, as they have a minimal mark-to-market impact when interest rates rise.

But keep in mind that investing in debt funds, in general, is not risk-free, and hence choose the safety of the principal over returns.

For an investment horizon of up to or less than a year, it would be better to stick to the best Liquid Funds and/or Overnight Funds having no exposure to private issuers.

Don't be discouraged by the new tax rule for debt mutual funds, wherein the capital gains on selling debt mutual funds units, irrespective of Short Term Capital Gain (STCG) or Long Term Capital Gain (LTCG) will be taxed at the marginal rate of taxation, i.e. as per one's income-tax slab.

[Read: Here the Key Changes in Mutual Fund Taxation After the Union Budget 2024-25]

Even now debt mutual funds have an edge over bank fixed deposits as regards returns are concerned. But avoid investing in debt funds that engage in yield hunting to clock higher returns. Be rational in your rational in your return expectations.

Whichever sub-category of debt mutual funds you are considering, ensure that you always assess your risk appetite and investment time horizon.

Be thoughtful in your approach.

Happy Investing!

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.