Mutual Funds to Keep Selling Govt Bonds Despite Relief from US Trade Deal

Indian government bonds rallied in early trading on Tuesday after the announcement of a trade agreement between India and the United States. However, traders said initial gains linked to a U.S.–India trade deal were capped by profit-taking and a supply-heavy market, with investors also becoming cautious ahead of the upcoming monetary policy decision.

Record Government Bond Sales by Mutual Funds

In January, Indian mutual funds net sold around ₹290 billion (about $3.2 billion) of government securities, the largest monthly sale on record. This trend continued into early February, with additional sales of about ₹53 billion on the first Monday of the month.

Mutual funds, which are the seventh-largest holders of Indian government bonds, have emerged as a key source of selling pressure in the market. According to ICRA Analytics, mutual funds sold more than 10% of their total government bond holdings, estimated at ₹2.81 trillion, during January.

Demand–Supply Imbalance Keeps Investors Cautious

Market participants said that while the tariff announcement linked to the U.S. trade pact has lifted sentiment, structural demand–supply challenges in the bond market remain unresolved.

Basant Bafna, Senior Fund Manager-Fixed Income at Mirae Asset, said the absence of any bond buyback announcement in the Union Budget, along with elevated gross borrowing levels, continues to weigh on market confidence.

Bafna noted that the recent Budget reinforced supply concerns, prompting investors to remain selective in their exposure to government securities. He said his preference remains tilted toward corporate bonds in the 1- to 3-year maturity segment, as well as certificates of deposit, where spreads continue to look attractive compared with historical averages.

Are Bond Yields Peaking as Risk Appetite Returns to Markets?

The pressure on yields has been visible across maturities. The 10-year benchmark government bond yield fell 4 basis points to 6.72%, as some market participants used the early rally to lock in gains. The yield had closed at 6.7% on Monday, marking its highest level in more than a year, highlighting the extent of recent pressure on bond prices.

The yield had already risen 11 basis points in the previous month, while shorter-dated securities saw yields climb by around 3–7 basis points, reflecting a broad-based repricing of rates amid supply concerns.

The prospect of an agreement with Washington lifted overall financial market sentiment by reviving hopes of foreign inflows. The rupee recorded its best single-day gain in seven years, rising 1.36% to ₹90.27 per dollar. Equity markets also responded sharply, with both benchmark indices posting their strongest session in nine months, closing more than 2.5% higher.

Heavy Borrowing Outlook Heightens Focus on RBI Liquidity Support

Market participants said supply concerns are likely to intensify in the coming year, with central and state governments expected to raise more than ₹30 trillion through gross borrowings in the next financial year starting in April, an increase of over 10% from current levels.

Some fund managers said a meaningful turnaround in bond prices would likely require a sizeable liquidity infusion from the Reserve Bank of India, given the elevated supply pipeline.

Avnish Jain, Fixed Income CIO at Canara Robeco Asset Management, said markets are likely to watch for any signals on liquidity support rather than rate action. He added that the RBI may continue to announce bond purchases to help bridge liquidity gaps in the banking system, even as the policy rate is expected to remain unchanged.

RBI Policy Expectations Firm Up

In a note, MUFG Bank said it expects the RBI to keep rates on hold at 5.25% through its forecast horizon, adding that the trade deal reduces the probability of additional rate cuts. MUFG said it expects the 10-year yield to approach 7% by the fourth quarter, reflecting supply pressures and a stabilising policy stance.

The trade pact has also strengthened the conviction that the RBI is nearing the end of its monetary easing cycle. The central bank has cut policy rates by 125 basis points since last February, but traders increasingly believe that further reductions are unlikely in the near term.

OIS Rates Reflect Trade Optimism

In the interest rate swaps market, overnight index swap (OIS) rates saw aggressive demand during the session on trade-related optimism. The one-year OIS rate fell 2 basis points to 5.52%, while the two-year OIS rate declined 5.25 basis points to 5.67%.

The five-year OIS rate dropped 7.5 basis points to 6.12%, signalling improved sentiment but also positioning ahead of the RBI meeting.

What Does This Mean for Investors?

The session underscored the push and pull in India’s bond market. While the U.S. trade pact has lifted risk sentiment and strengthened expectations that the RBI’s easing phase is ending, heavy government borrowing and supply concerns continue to cap bond rallies.

With the policy decision due shortly, yields are likely to remain sensitive to RBI guidance and supply dynamics, with traders preferring to book gains rather than build large directional positions.

Source

Economic Times

Reuters

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