What should India’s fixed-income investors do after US Fed rate cut?

Bond prices and yields have an inverse relationship.

The US Federal Reserve on September 18 cut interest rates by an aggressive 50 basis points (bps), raising hopes of a similar move by the Reserve Bank of India.

Fed chair Jerome Powell indicated there was more to come. "We made a good strong start and I am very pleased that we did," Reuters quoted Powell as saying at a press conference after the benchmark policy rate was reduced to the 4.75-5 percent range.

“It is clear that the worse-than-expected July employment data was the turning point. The Dot Plot is indicating an additional 50 bps of additional by year- end. The focus is clearly back to maximum employment mandate of Federal Reserve,” said Siddharth Chaudhary, Senior Fund Manager – Fixed Income, Bajaj Finserv Mutual Fund.

What does Fed rate cut mean for Indian debt investors?

Bond yields usually move in anticipation of interest rate changes. Over the past year, India’s 10-year bond yield has been on a downward trend, falling from 7.1 percent to around 6.85 percent level this week.

Debt market experts see the 10-year yield drifting towards 6.75 percent after September, with a year-end target of around 6.55 percent.

How will falling yields impact bond mutual funds?

Bond prices and yields have an inverse relationship. When yields fall, the prices of bonds typically rise. Since debt mutual funds hold a portfolio of bonds, the net asset value (NAV) of the fund usually increases as bond prices go up.

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Though bond funds have made good gains over the last one year, experts anticipate another leg of rally. The overall situation remains bond-positive, with a clear expectation of rate cuts and a favourable demand-supply situation, they said.

What does this mean for investors?

Dhawal Ghanshyam Dhanani, Fund Manager, SAMCO Mutual Fund, said the Fed cut marks the beginning of a pivot in interest rates after more than four years. “Though the final impact on the markets will be dictated by other economic data such as labour rates, inflation and unemployment rate that still needs to be keenly observed,” Dhanani said.

Amid global monetary easing, Indian bonds continue to be attractive, supported by robust and stable macroeconomic fundamentals and favourable demand-supply dynamics.

What strategy to follow?

The Fed’s rate decision is expected to lower borrowing costs, stimulating economic activity and boosting Indian bond prices, especially long-duration bonds, as yields fall.

This could lead to a global rally in debt markets, improving liquidity and making it cheaper for businesses and consumers to borrow, Fisdom Research said.

The rate cut is also expected to weaken the dollar, increasing foreign demand for US bonds.

“After the Fed's 50 bps rate cut, long-duration funds are the better option. These funds are highly sensitive to interest rate changes, meaning they will benefit significantly from falling yields as bond prices rise. This provides potential for capital appreciation, making them attractive in a declining interest rate environment,” said Nirav Karkera, Head of Research at Fisdom.

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At the same time, short-duration funds, while less volatile and more stable, will not see the same level of gains because interest rate movements have lesser affect on them.

If the goal is to maximise returns post-rate cut, long-duration bonds offer better prospects for capital appreciation, Karkera said.

The strategy can be to increase exposure to long-duration bonds to take advantage of the potential capital appreciation as bond prices rise with falling yields. Long-duration funds are expected to benefit the most in a declining rate environment.

Fixed deposit rates to fall?

Interest rates often influence fixed deposit (FD) rates. When central banks adjust interest rates, banks typically respond by changing the rates they offer on fixed deposits.

If interest rates rise, FD rates are usually hiked to attract more deposits. Conversely, if rates are cut, FD rates may decrease, too. Individual banks, however, may also consider factors such as competition and their funding needs when setting rates.

As written by Moneycontrol, a slew of higher-rate, limited period fixed deposit (FD) schemes are set to expire soon.

September 30 is the deadline to invest in special-rate, specific tenure fixed deposits offered by three major banks — State Bank of India (SBI), IDBI and Indian Bank. Such schemes offer rates ranging from 7.05-7.35 percent per annum over 300-444-day tenures.

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Individuals looking for stable returns could consider locking into these special FDs, which offer higher-than-regular interest rates, now, financial advisers said.

Will RBI follow the Fed rate cut?

Experts are of the opinion that the RBI may not immediately follow suit, unless price continues to cool. Its focus will remain on managing inflation and maintaining growth. At the same time, they do not rule an immediate shift in stance.

“The US isn’t the first economy to have cut rates, the UK, Eurozone and Canada have already begun this cycle while India is on a wait and watch mode. History shows that more often than not India has followed the US in any interest rate pivot and this time, too, there is high probability that we will follow suit,” said Dhanani.