►Higher yields across economies : The Reserve Bank of India (RBI) retained a pause on interest rates for the tenth consecutive time; but changed its stance from 'withdrawal of accommodation' to 'neutral'. Expectations are for lower interest rates across the US, UK and Europe over the next few months. Despite the rate cuts, yields rose over the month. One of the main reasons for the rise in US Treasury yields has been the growing likelihood of Donald Trump getting elected as the US President. This could result in a higher US fiscal deficit and increased near-term inflation due to tariffs, tax cuts, and potential delays in Federal Reserve (Fed) rate cuts. Another reason for uptick in yields has been China's stimulus package of RMB 4 trillion (approximately $586 billion) to boost its economy also led to uptick in crude and other commodities and also in yields.

► Inflationary pressures rise : Headline inflation reached 5.49%, surpassing market expectations due to base effects and rising vegetable prices. We anticipate the October figure to also be on the higher side, around 5.75%. However, we expect headline CPI to return to the 4.5% range after November and do not foresee any changes in the full-year CPI projections.

► Banking liquidity in surplus : Banking liquidity has remained in surplus, supported by government buybacks and slower credit growth, which have helped stabilize money market yields. The year-to-date incremental creditdeposit ratio is below 60%, and we believe banking liquidity will remain comfortable for this quarter.

Market view

At the current juncture, it is interesting to note that yields are up despite the Fed rate cut, change in stance by the RBI and easy banking liquidity. As already mentioned earlier, yields are higher due to a higher probability of Trump getting elected. Nevertheless, even if Trump is elected as the president, the economy is slowing own and the current macro environment makes us believe the Fed could deliver 50 bps cut this year and 100 bps cut next year. US Treasury futures are not currently pricing in aggressive rate cuts. As such, we believe the sell-off in US yields is largely overdone and expect US Treasury yields to soften.

Separately, though, the measures announced by the Chinese government are of significant magnitude It is too early to conclude their execution and impact on global macros, inflation, and commodities.

In India, we believe that the change of stance, the RBI has already pivoted. As India's growth remains strong, we do not expect the RBI to be aggressive in cutting rates and expect 50 bps of rate cuts in next 6 months. We believe that banking liquidity would continue to remain positive in this quarter and expect money market yields to remain stable. Due to favourable demand supply dynamics, we continue to have a higher bias towards government bonds.

Risks to view
We see two risks to our long duration view.
• US elections- Trump getting elected can lead to volatility in bond market yields in near term as it can lead to higher US bond yields due to fiscal expansion and higher inflation
• Recent measures taken by the Chinese government as they can break the disinflation cycle and can lead to high commodity prices, which in turn can impact INR and bond yields

Positioning & Strategy
We have been maintaining a higher duration across all our funds and guiding the rally in bonds since March 2024. Though we have already witnessed a more than 40 bps of rally in yields since the beginning of the year, positive demand-supply dynamics for government bonds and expected rate cuts will continue to keep bond markets happy, and we can expect another 25-30 bps of rally in the next 3-6 months. Accordingly, from a strategy perspective, we have maintained an overweight duration stance within the respective scheme mandates with a higher allocation to Government bonds.
What should investors do?
• Investors should continue to hold duration across their portfolios.
• Incremental gains in long bonds would be with policy stance change or rate cuts.
• In line with our core macro view, we continue to advise short- to medium-term funds with tactical allocation of gilt funds to our clients.

Source: Bloomberg, Axis MF Research.