6 days ago
Fixed income market outlook: why short-term bonds may outperform in 2H 2025
Synopsis India's bond market is evolving amid geopolitical tensions, softening inflation, and stable currency trends. Axis MF's July 2025 outlook favors short-term corporate bonds over long-duration G-Secs, citing better yields and risk-reward. Investors are advised to stay tactical with duration and focus on selective credits for 2H 2025. In a world grappling with geopolitical uncertainties and changing interest rate dynamics, India's bond market stands at a crucial juncture.
ADVERTISEMENT According to the Fixed Income Market Outlook (July 2025) report by Axis Mutual Fund, abundant liquidity, falling inflation, and a shallow rate cut cycle are shaping a nuanced bond market strategy for the months geopolitical tensions between Israel and Iran have driven global investors towards safer assets like bonds and gold. In the US, 10-year Treasury yields slipped by 17 basis points to 4.23%. Meanwhile, Indian 10-year government bond yields inched up by 3 basis points to settle at 6.32%, largely due to abundant banking liquidity and moderating inflation trends.
The Reserve Bank of India (RBI) conducted a ₹84,975 crore VRRR (Variable Rate Reverse Repo) auction to manage excess liquidity. Overnight rates are currently trading below the Standing Deposit Facility (SDF), prompting the central bank to maintain short-term policy interventions. India's headline inflation fell to 2.8% in May 2025, thanks to easing food prices and an expected above-normal monsoon. Analysts expect inflation to stay around or below 3% in the near term. Industrial production slowed to 1.2% in May, with the mining and electricity sectors dragging overall growth. However, India posted a robust current account surplus of 1.3% of GDP in Q4FY25—the strongest in over 15 years—driven by resilient service exports and front-loaded goods shipments ahead of US tariffs.
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The rupee remained broadly stable against the US dollar, as the greenback weakened against most major currencies.
While bond markets have benefited from a strong rally over the past 12 months, analysts now expect the upside to be limited, particularly for long-duration government bonds. With much of the rate-cut-driven rally already priced in (10-year yields have already fallen by 70–75 bps over the last year), experts predict that yields will likely remain range-bound between 6% and 6.40% for 10-year G-Secs in the coming months.
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The report emphasizes a clear tactical shift towards short-duration bonds. Several factors support this view: Surplus system liquidity and subdued credit growth favor short-end corporate bonds.
A shallow rate cut cycle and limited OMO (Open Market Operations) purchases further restrict long-duration bond rallies.
Corporate bonds with maturities of 1 to 5 years are expected to outperform long bonds from a risk-reward standpoint.
AAA-rated corporate bonds maturing within 3 to 10 years are likely to offer yields between 6.50% and 6.75%, providing incremental gains of 50–100 basis points.
Globally, while tariff uncertainties between the US and its trading partners are easing, negotiations remain ongoing. The US Federal Reserve is expected to resume its rate-cutting cycle soon, with two cuts likely in 2025 as growth slows and labor market data weakens. However, the Fed's cautious approach keeps markets volatile.
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Given the current environment, investment experts recommend: Maintaining allocations to short- to medium-term bond funds.
Gradually adding duration during yield spikes.
Favoring government securities (G-Secs) in long-term portfolios while increasing exposure to 1–5-year corporate bonds for better near-term returns.
With the bulk of the bond rally behind us, the report advises investors to focus on short-term corporate bond funds and tactical gilt funds. Selective credits also remain attractive due to improving macro fundamentals and corporate profitability.
ADVERTISEMENT In short, the fixed-income space continues to offer opportunities—but disciplined portfolio allocation, duration management, and selective sector exposure will be critical for capturing returns in 2H 2025.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
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