The Curious Case of Fixed Income In 2025
Are you worried about:
- Why fixed income isn’t performing for you in 2025?
- Where interest rates are headed?
- How you can play it safe in a volatile market?
Then we’ve got just the right thing for you. Tune in to our webinar on 5th July where we decode the new interest rate cycle and help you capture investment opportunities!
Bond Prices & Interest Rates
Bond market investors have held on to the notion that bond prices and interest rates move in opposite directions. So, when interest rates trend down, bond prices move up and investors make mark to market gains on their portfolio holdings. But interest rates in India have gone down a fair bit in 2025 and bond portfolios are in the red. In this month’s outlook we’re going to:
- Study why this happened
- Decode what it means for investors today
- Analyse whether there’s any merit in holding on to fixed income
Domestic Macros
Let’s put Indian macros in perspective. On the growth front, India is slated to grow at 6.0%-6.5% this year. This number is impressive on a global level but lacklustre when compared with where India wants to be. 2024 was a testing year for inflation with vegetable prices playing spoilsport. Today, the Indian economy is coming off a period of high inflation and heading into a period of low growth. This is the perfect policy setting for lower interest rates. Cutting interest rates has the double advantage of stoking inflation and growth.
The RBI has acknowledged this early on and introduced a slew of measures to bring us back on track:
Why did markets react badly to the RBI’s June policy announcement?
Here are three reasons why this happened:
- End of the Rate Cut Cycle
- India US Interest Rate Differential
- No policy room to cut rates
End of the Rate Cut Cycle
Markets were spooked by the RBI’s decision to change its stance so quickly. With a mega rate cut and a plan to keep liquidity in surplus through the year, analysts felt that these actions marked the end of the rate cut cycle.
However, the important thing to note is that the RBI lowered its inflation forecast and maintained it’s growth forecast. Later in June, the governor clarified saying that if inflation moves lower that could open up policy space for further rate cuts.
Interest Rate Differentials
One theory, that market participants put forth is that global investors would prefer US treasuries over Indian bonds. The logic being that the difference between sovereign yields in India and the US is at a historic low. The Repo rate stands at 5.50% while the Fed Funds rate is pegged at 4.25%-4.50%. With US yields rising and Indian yields declining, the risk reward for global investors has been in favour of US treasuries. The difference in returns after accounting for currency risk doesn’t seem worth it.
Given where geopolitics and global policy is today, the dollar is set to depreciate. If the US wants to export more to the rest of the world and reduce its trade deficit, a weaker dollar is on the cards. More importantly, with Moody’s recently downgrading US government debt, yields and dollar values may be moving closer to their fundamental valuations. As more bilateral agreements are negotiated and executed, the dollar may not remain the preferred currency for global trade. The mechanics of trade settlement are changing with settlements happening in alternate currencies or through goods and services.
While FIIs have been net sellers of Indian debt for the most part of 2025, it looks like June may be an inflection point. Sentiment seems to be turning in favour of Indian fixed income.
[Source: FII trading data – Moneycontrol]
MF Selling
Now we ask the tough questions, why are DIIs like mutual funds exiting debt? Equity markets have seesawed through 2025. The markets faced a drawdown period between September 2024 and March 2025. Investors sought stability during the drawdown period and have witnessed a bounce back since.
While the context for equity investing has shifted dramatically, investors lack the mental preparation to lower equity return expectations. Investors are clearly preferring equity over debt without understanding the risks. In general, the mutual fund industry seems averse to taking a duration call, and transmission has been swift on the shorter end of the curve. So, investors and managers are avoiding the short end of the curve because of low prospective returns and the long end of the curve because of negative returns.
[Source: Moneycontrol – MF Trading Activity]
Investment Strategy
There’s no better time to be a contrarian. The yield spike has created an opportunity for investors to enter debt at better valuations or add a layer to their investment portfolios. In this market context, debt can deliver what it promises, it remains to be seen whether equity will be able to meet investor expectations.
