RBI rate cut: Investors might have to look for bonds with higher yields

Even lenders with access to low-cost funds have been found to be charging significantly higher margins than the industry norm, which in several instances appear excessive

With the Reserve Bank of India (RBI) turning neutral in the latest Monetary Policy Committee (MPC) meeting, further rate cuts look unlikely, thus capping bond price gains. Experts feel the window for capital appreciation may have closed, making bonds less appealing.

What happened in the RBI meet?

The MPC on June 6 voted 5-1 to cut the repo rate by 50 basis points (bps) to 5.5 percent. This was larger than what the bond market expected. Additionally, the central bank also slashed the Cash Reserve Ratio (CRR) maintained by banks by 100 bps to 3 percent. This is expected to add liquidity to the tune of Rs. 2.5 lakh crore.

“We believe the RBI would be very careful in easing the monetary policy further, having reduced the repo by 100 bps in quick succession since February 2025… Since the MPC also decided to change the stance from “accommodative” to “neutral,” it will carefully assess the incoming data and the evolving outlook to chart the future course in order to strike the right growth-inflation balance,” Franklin Templeton Mutual Fund said in a note.

Also read | RBI monetary policy: Relief for borrowers as home loan interest rates set to fall significantly

Significance of RBI's action

As per Mahendra Kumar Jajoo, Chief Investment Office–Fixed Income, Mirae Asset Mutual Fund, because of the policy rate cut and the proposed the CRR cut, short-term rates have come down by 15-20 bps.

The one-year Certificate of Deposit (CD) rates are now at around 6.20 percent and three-year corporate bonds are now around 6.35-6.40 percent.

“So, the impact is positive on short-term rates. But the long-term 10+ year yield has gone up a few bps, because there is a change in the stance to neutral, which indicates that there's isn't much likelihood of any further rate cuts. With interest rates at 5.5 percent, the market is already anchoring the 10-year yield about 75 bps above this, at about 6.25 percent. I am expecting 10-year yield get closer to 6 percent before it bottoms out,” he said.

RBI's repo rate cut would typically boost bond prices due to the inverse relationship between bond prices and interest rates – when rates fall, bond prices rise.

“However, given the swift market reaction, bond prices have likely already adjusted to reflect the rate cut. With the RBI shifting to a neutral stance, further rate cuts are uncertain, limiting potential upside,” said Dharan Shah, Founder, Tradonomy.AI.

Shah feels that the window for benefitting from appreciation in bond prices may have already closed, making it less attractive to invest in bonds at this point. “The market's efficiency in pricing in the rate cut reduces the potential for further gains," he said.

What will happen with the 10-year bond yield?

On the day of the new policy announcements, the Indian 10-year benchmark bond yield tested the 6.10 percent level but settled at 6.28 percent as the RBI changed its stance from “accommodative” to “neutral.”

Deepak Panjwani, Head-Debt Markets at GEPL Capital, expects the 10-year benchmark yield to move below 6 percent before the next policy change, and feels it can test the 5.90 percent level in future.

Also read | RBI repo rate cut: Depositors need to brace for lower FD rates, rethink savings strategy

Edelweiss Mutual Fund expects the benchmark 10-year yield to trade in a range of 6.15-6.25 percent in the near-term, and grind towards 6 percent by December 2025.

What should debt fund investors do?

"It (RBI’s rate cut) is positive for investors already invested in fixed income funds. Portfolio yields will come down. However, investors who are looking for higher carry income will have to take higher duration and credit risk," said Sandeep Bagla, CEO, TRUST Mutual Fund.

While falling interest rates increase the returns from debt funds, especially longer duration ones, the rate cut seems to have been already priced in by the fixed-income markets.

“The change of monetary policy stance from accommodative to neutral has reduced the chances of further rate cuts in the near short term. Thus, with other things being equal, returns from debt funds, especially the longer duration ones, are likely to moderate from here,” said Santosh Agarwal, Chief Executive Officer, Paisabazaar.

Around a year back, experts were pitching for long-duration bond funds since they benefit from falling interest rates as they hold bonds with extended maturity periods, allowing investors to capitalise on price appreciation.

Also read | These debt funds are defying gravity, but is the risk worth the return?

For long duration bond investors, Jajoo, said, “At this point they should stay invested and see how the market develops over the next couple of months. In a classic fixed-income market, the yield curve is flattest when the rate cut starts, and steepest when the rate cut ends. For new investors, short and low-duration bonds are a good entry point, followed by long-duration bonds.''

Panjwani, meanwhile, suggests, dynamic bond funds as these adjust their portfolio duration based on interest rate expectations.

“With the expectation of rate cuts, short-term debt funds may be a good option to minimise interest rate risk. Further, credit risk funds invest in lower-rated bonds that may offer higher yields, but investors need to be cautious,” Panjwani said.

Strategy for fixed-income investors

“With rate cuts off the table for now, consider locking in current yields through high-quality medium-to-long-duration bonds or fixed deposits (FDs),” said Agarwal.

Also read | Defence, gold and BFSI mutual funds shine in a stormy 2025

The 50-bps repo rate cut would not impact existing FDs. However, investors planning to invest in FDs should lock in FDs available at attractive interest rates before the repo rate cut and CRR reduction is transmitted to FD rates.

“Some small finance banks are still offering FD rates of 8+ percent (per annum). While booking FDs, depositors should prefer those offering higher interest rates for longer tenures as that would allow them to earn higher interest income during the rate easing cycle,” explained Agarwal.

Panjwani said investors can also look for bonds with high yields (such as State Guaranteed bonds) and tax-free bonds, which are better placed at this point.